like-kind exchange planning in real estate, part 1 & … · like-kind exchange planning in real...

LIKE-KIND EXCHANGE PLANNING IN REAL ESTATE, PART 1 & PART 2

First Run Broadcast: May 2 & 3, 2013

1:00 p.m. E.T./12:00 p.m. C.T./11:00 a.m. M.T./10:00 a.m. P.T. (60 minutes)

This program will provide you with a guide to sophisticated like-kind exchange planning in a

market where prices have stabilized and are rising again. The program will discuss planning

problems and drafting traps with forward and reverse exchanges, including with related parties.

It will also cover techniques for minimizing the adverse effect of the receipt of “boot” in and the

use of single-member LLCs and Family Limited Partnerships to increase the attractiveness of

exchanges. Alternatives to like-kind exchanges, including mixing bowl transactions and

leveraged acquisitions, will also be covered. This program will provide you with a framework for

understanding advanced like-kind exchange planning formats, hidden planning and drafting

traps, and effective alternatives when like-kind exchanges are not appropriate.

Day 1 – May 2, 2013:

Framework of advanced like-kind exchanges techniques and alternatives

Use of trusts, single-member LLCs, and Family Limited Partnerships

Simultaneous exchanges – the problematic use of intermediaries and key drafting traps

Deferred exchanges – disqualified parties and safe harbors

Techniques to solve the problem of “boot” in a transaction, including special allocations,

installment sales, cross purchases and redemptions

Day 1 – May 3, 2013:

Reverse exchanges, parking transactions, build-to-suit exchanges

Changes to the “related party” transaction rules

Problems associated with over-leveraged property

Alternatives to like-kind exchanges, including mixing bowl transactions, leveraged

acquisitions and freeze partnerships

Circumstances when alternatives to like-kind exchanges are the better choice

Speakers:

Brian J. O'Connor is a partner in the Baltimore office of Venable, LLP, where he is co-chair of

the firm’s tax and wealth planning group. He provides sophisticated tax and business advice to

closely-held and publicly-traded businesses and their owners. Before joining Venable, Mr.

O’Connor was an attorney-advisor in the Office of the Chief Counsel of the IRS, where he

worked on high profile legislative projects, regulations and other published guidance relating to

pass through entities. Mr. O’Connor received his J.D., magna cum laude, from Washington and

Lee University School of Law and his LL.M. in tax law, with distinction, from Georgetown

University Law Center.

Norman Lencz is a partner in the Baltimore, Maryland office of Venable, LLP, where his

practice focuses on a broad range of federal, state, local and international tax matters. He

advises clients on tax issues relating to corporations, partnerships, LLCs, joint ventures and real

estate transactions. He also has extensive experience with compensation planning in closely held

businesses. Mr. Lencz earned his B.S. from the University of Maryland and his J.D. from

Columbia University School of Law.

VT Bar Association Continuing Legal Education Registration Form

Please complete all of the requested information, print this application, and fax with credit info or mail it with payment to: Vermont Bar Association, PO Box 100, Montpelier, VT 05601-0100. Fax: (802) 223-1573 PLEASE USE ONE REGISTRATION FORM PER PERSON. First Name: _____________________ Middle Initial: _____Last Name: __________________________

Firm/Organization:____________________________________________________________________

Address:___________________________________________________________________________

City:__________________________________ State: _________ ZIP Code: ______________

Phone #:________________________ Fax #:________________________

E-Mail Address: ____________________________________________________________________

I will be attending:

Like-Kind Exchange Planning in Real Estate, Part 1

Teleseminar May 2, 2013

Early Registration Discount By 04/25/13 Registrations Received After 04/25/13

VBA Members: $70.00 Non VBA Members/Atty: $80.00

VBA Members: $80.00 Non-VBA Members/Atty: $90.00

NO REFUNDS AFTER April 25, 2013

PLEASE NOTE: Due to New Hampshire Bar regulations, teleseminars cannot be used for New Hampshire CLE credit

PAYMENT METHOD:

Check enclosed (made payable to Vermont Bar Association): $________________ Credit Card (American Express, Discover, MasterCard or VISA) Credit Card # ________________________________________Exp. Date_______ Cardholder: ________________________________________________________

Vermont Bar Association

CERTIFICATE OF ATTENDANCE

Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: May 2, 2013 Seminar Title: Like-Kind Exchange Planning in Real Estate, Part 1 Location: Teleseminar Credits: 1.0 General MCLE Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.

VT Bar Association Continuing Legal Education Registration Form

Please complete all of the requested information, print this application, and fax with credit info or mail it with payment to: Vermont Bar Association, PO Box 100, Montpelier, VT 05601-0100. Fax: (802) 223-1573 PLEASE USE ONE REGISTRATION FORM PER PERSON. First Name: _____________________ Middle Initial: _____Last Name: __________________________

Firm/Organization:____________________________________________________________________

Address:___________________________________________________________________________

City:__________________________________ State: _________ ZIP Code: ______________

Phone #:________________________ Fax #:________________________

E-Mail Address: ____________________________________________________________________

I will be attending:

Like-Kind Exchange Planning in Real Estate, Part 2

Teleseminar May 3, 2013

Early Registration Discount By 04/26/13 Registrations Received After 04/26/13

VBA Members: $70.00 Non VBA Members/Atty: $80.00

VBA Members: $80.00 Non-VBA Members/Atty: $90.00

NO REFUNDS AFTER April 26, 2013

PLEASE NOTE: Due to New Hampshire Bar regulations, teleseminars cannot be used for New Hampshire CLE credit

PAYMENT METHOD:

Check enclosed (made payable to Vermont Bar Association): $________________ Credit Card (American Express, Discover, MasterCard or VISA) Credit Card # ________________________________________Exp. Date_______ Cardholder: ________________________________________________________

Vermont Bar Association

CERTIFICATE OF ATTENDANCE

Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: May 3, 2013 Seminar Title: Like-Kind Exchange Planning in Real Estate, Part 2 Location: Teleseminar Credits: 1.0 General MCLE Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.

PROFESSIONAL EDUCATION BROADCAST NETWORK

Speaker Contact Information

LIKE-KIND EXCHANGE PLANNING IN REAL ESTATE,PART 1 & PART 2

Brian O'ConnorVenable, LLP - Baltimore, Maryland(o) (410) [email protected]

Norman LenczVenable LLP – Baltimore, Maryland(o) (410) [email protected]

THE LIKE KIND EXCHANGE:

A CURRENT REVIEW

Stefan F. Tucker, Esq.Brian J. O’Connor, Esq.

Norman Lencz, Esq.Tammara F. Langlieb, Esq.

Venable LLPWashington, D.C.

May 2013

-i-DC3/137915 v9

TABLE OF CONTENTS

I. OVERVIEW ....................................................................................................................... 1

II. BASICS OF LIKE KIND EXCHANGES .......................................................................... 1A. General Rules.......................................................................................................... 1B. Exchanges ............................................................................................................. 20C. Designations of Replacement Property -- Generally ............................................ 22

III. EXCHANGES WITH BOOT........................................................................................... 24A. Generally............................................................................................................... 24B. The Impact of Mortgages...................................................................................... 26C. Installment Sales ................................................................................................... 29

IV. EXCHANGES BETWEEN RELATED PERSONS -- TRIGGERINGDEFERRED GAIN........................................................................................................... 30A. Background ........................................................................................................... 30B. General Rules........................................................................................................ 30C. Exceptions (Certain Dispositions Not Taken into Account)................................. 31D. Treatment of Certain Transactions........................................................................ 33

V. SIMULTANEOUS EXCHANGES .................................................................................. 37A. Description............................................................................................................ 37B. Difficulties of Simultaneous Exchange ................................................................ 37C. Use of an Intermediary.......................................................................................... 38D. Like Kind Transaction Agreement........................................................................ 38E. Illustrations ........................................................................................................... 38

VI. DEFERRED LIKE KIND EXCHANGES........................................................................ 40A. Overview............................................................................................................... 40B. Actual and Constructive Receipt of Money or Other Property -- The Safe

Harbors.................................................................................................................. 43C. The Disqualified Person........................................................................................ 50D. Identification and Receipt Requirements.............................................................. 51E. Coordination of Deferred Like Kind Exchange Rules with Installment Sale

Rules ..................................................................................................................... 56

VII. REVERSE EXCHANGES ............................................................................................... 58A. Basics .................................................................................................................... 58B. Types of Reverse Exchanges ................................................................................ 58C. Level of Risk......................................................................................................... 59D. Authority Prior to Rev. Proc. 2000-37.................................................................. 60E. Rev. Proc. 2000-37: Safe Harbor for Parking Arrangements .............................. 61F. Build-to-Suit Rulings ............................................................................................ 64G. Joint Committee on Taxation Recommendation for Simplification ..................... 66

VIII. CHECKLIST FOR DEFERRED LIKE KIND EXCHANGES........................................ 67

-1-

I. OVERVIEW

Without Sec. 1031, I.R.C., the income tax consequences of any exchange would be thesame as those of a sale. The amount of gain or loss would be determined by calculating thedifference between the adjusted basis of the asset relinquished and the fair market value of theproperty received. Sec. 1001(b), I.R.C.

II. BASICS OF LIKE KIND EXCHANGES

A. General Rules -- Under Sec. 1031(a)(1), I.R.C., gain or loss will not berecognized when property that is held for productive use in a trade or business or investmentpurposes is exchanged solely for property of like kind to be held either for productive use intrade or businesses or for investment.

1. Exclusions

a. Sec. 1031(a)(2), I.R.C. specifically excludes from like kindtreatment the exchange of:

(1) stock in trade or other property held primarily for sale,

(2) stocks, bonds or notes,

(3) other securities or evidences of indebtedness or interest,

(4) interests in a partnership,

(5) certificates of trust or beneficial interests, or

(6) choses in action.

b. Note that, to the extent the underlying assets of a partnershipconstitute real property, an exchange of a partnership interest for real property does not qualifyas like kind for nonrecognition treatment under Sec. 1031, I.R.C. (See MHS Co., Inc. v.Comm’r, 35 TCM 733 (1976), aff’d 575 F.2d 1177 (CA6 1978).) This conclusion is based onthe fact that a partnership interest is considered as personalty rather than realty. However, wherea partnership has in effect a valid election under Sec. 761(a), I.R.C., the interest in thepartnership is treated as an interest in each of the assets of the partnership and not as an interestin the partnership. Sec. 1031(a)(2), I.R.C. In addition, where the transfer results in the taxpayeracquiring 100 percent of the interests in the partnership, the taxpayer will be treated as acquiringthe property, rather than a partnership interest. See Priv. Ltr. Rul. 200807005 (November 9,2007).

c. Certainly, the exclusion of partnership interests from like kindtreatment is not intended to apply to an exchange of interests in the same partnership. See

-2-

General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984, preparedby the Staff of the Joint Committee on Taxation, at 245-247. But see Priv. Ltr. Rul. 9741017(July 10, 1997), wherein the Service ruled that a proposed exchange between two brothers, eachof whom owns one-half of an entity that owns 10 rental properties, will not qualify for Sec. 1031,I.R.C. nonrecognition treatment because the parties would be exchanging partnership interests.Management differences motivated the brothers to realign the ownership of nine of the propertiesso that one owned six and the other owned three. The Service ruled that the exchange did notqualify under Sec. 1031, I.R.C., without referencing or taking into account the legislative intentexplained in the language of the General Explanation of the 1984 Act.

d. Note that Rev. Proc. 2002-22, 2002-1 C.B. 733, superseding Rev.Proc. 2000-46, 2000-2 C.B. 438, sets forth the following conditions under which the Service willconsider a request for a ruling that an undivided fractional interest in rental real property (otherthan mineral property) is not an interest in a business entity, within the meaning of Reg. §301.7701-2(a). This is significant because under Sec. 1031(a)(2)(D), I.R.C., nonrecognition ofgain or loss under the like kind exchange rules does not apply to the exchange of an interest in abusiness entity.

(1) Each of the co-owners must hold title to the property (eitherdirectly or through a disregarded entity) as a tenant in common under local law. The title to theproperty as a whole may not be held by an entity recognized under local law.

(2) The number of co-owners must be limited to no more than35 persons. A husband and wife are treated as a single person.

(3) The co-ownership may not file a partnership or corporatetax return, conduct business under a common name, execute an agreement identifying any or allof the co-owners as partners, shareholders or members of a business entity, or otherwise holditself out as a form of business entity.

(4) The co-owners cannot have held interests in the propertythrough a partnership or corporation immediately prior to the formation of the co-ownership.

(5) The co-owners may enter into a limited co-ownershipagreement that may run with the land. In addition, the co-owners must retain the right toapprove the hiring of any manager, the sale or other disposition of property, any lease(s) of aportion or all of the property, or the creation or modification of a blanket lien.

(6) Each co-owner must have the rights to transfer, partitionand encumber such co-owner’s undivided interest in the property without the agreement orapproval of any person. Restrictions on the right to transfer, partition or encumber interests inthe property that are required by a lender and that are consistent with customary commerciallending practices are not prohibited.

(7) If the property is sold, any debt secured by a blanket lienmust be satisfied and the remaining sales proceeds must be distributed to the co-owners.

-3-

(8) Conditions concerning the proportionate sharing of profitsand losses, proportionate sharing of debt, options, business activities, management and brokerageagreements, leasing agreements and loan agreements are also specified.

(a) Recently, the Service ruled that the appointment ofcertain of the tenant-in-common owners as agents and the temporary pooling of funds by thetenant-in-common owners on a non-pro rata basis because the master tenant entered intobankruptcy proceedings did not cause the tenant-in-common owners to be considered partners ina partnership. PMTA 2010-05 (March 15, 2010).

(b) The Service based its decision on the fact that theappointment of certain of the tenant-in-common owners as agents and the temporary pooling offunds on a non-pro rata basis was a result of the urgency of the bankruptcy of the master tenant.The agents tried to equalize the funds among the tenant-in-common owners within the 31 daysprescribed by Rev. Proc. 2002-22, but encountered difficulty in obtaining the contact informationand identity of all the owners.

(9) The Revenue Procedure provides special rules for multipleparcels, as follows:

(a) Multiple parcels of property are treated as a singleproperty to the extent that (i) the parcels are owned by co-owners, (ii) the parcels are leased to asingle tenant pursuant to a single lease agreement, and (iii) any debt of one or more co-owners issecured by all of the parcels.

(b) The Service will not consider a ruling request in themultiple parcel scenario unless (i) each co-owner’s percentage interest in each parcel is identicalto that co-owner’s percentage interest in every other parcel, (ii) each co-owner’s percentageinterests in the parcels cannot be separated and traded independently, and (iii) the parcels ofproperty are properly viewed as a single business unit. Contiguous parcels will be treated as asingle business unit.

e. In light of the difficulty of satisfying all of the conditions set forthin Rev. Proc. 2002-22, it is not surprising that the Service has issued few private letter rulingsunder this Revenue Procedure. In identical rulings, the Service has held that an undividedfractional interest in a piece of property would not constitute an interest in a business entityunder Reg. § 301.7701-2(a) for the purpose of qualification of the undivided fractional interest aseligible replacement property under Sec. 1031(a), I.R.C., where (i) the co-owners of the propertyhad to approve sales, leases, negotiation of debt secured by a lien and the hiring of the managerand (ii) either co-owner could, without the approval of the other owner, engage in activities suchas pledging its interest as collateral, which could diminish the value of the other owner’s interest.See Priv. Ltr. Ruls. 200625009 and 200625010 (each March 1, 2006).

(1) See also Priv. Ltr. Ruls. 200826005, 200829012 and200829013 (each March 17, 2008), where similar facts were presented, and Service asserted thesame analysis and conclusion in each.

-4-

(2) See also Priv. Ltr. Rul. 200513010 (December 6, 2004),concluding that, notwithstanding the sponsor’s permanent retention of an undivided tenant-in-common interest in a multi-tenant building subject to a blanket lien, an undivided fractionalinterest in such property will not constitute an interest in a business entity under Reg.§ 301.7701-2(a) for purposes of qualification of the undivided fractional interest as eligiblereplacement property under Sec. 1031(a), I.R.C.; and Priv. Ltr. Rul. 200327003 (March 7, 2003),concluding that an undivided fractional interest in a single tenant, triple net leased property notsubject to a mortgage is eligible replacement property under Sec. 1031(a), I.R.C.

f. For exchanges completed after May 22, 2008, the term “stock”does not include a qualified share in a mutual ditch, reservoir or irrigation company.Consequently, nonrecognition of gain or loss under the like kind exchange rules applies to theexchange of a qualified share in a mutual ditch, reservoir or irrigation company.

g. “Property held primarily for sale” is not eligible for like kindtreatment. Note that the statutory language of Sec. 1031, I.R.C., does not include the language ofSec. 1221, I.R.C., “to customers in the ordinary course of his trade or business”. Accordingly,property that qualifies for capital gains treatment under Sec. 1221, I.R.C. may not necessarilyqualify for like kind treatment.

(1) In Neal T. Baker Enterprises, Inc. v. Comm’r, 76 TCM 301(1998), the taxpayer (“NTB”) engaged in real estate subdivision and development and leasedrestaurants to a related corporation. In 1978, NTB acquired vacant land in Beaumont, California,initially planning to subdivide and sell the property. Eleven years later, NTB agreed to exchangethe remaining undeveloped lots for other property. NTB treated the transaction as a like kindexchange under Sec. 1031(a), I.R.C. The Service disallowed the Sec. 1031, I.R.C.nonrecognition treatment, arguing that the property was held primarily for sale pursuant to Sec.1031(a)(2)(A), I.R.C. NTB contended that it held the property for investment. NTB relied onthe factors established in Sec. 1221, I.R.C. cases, which are used to determine whether propertywas primarily held for sale to customers in the ordinary course of business. The Court noted thatthese factors “provide guidance” in deciding if the property was held primarily for sale, butspecifically disregarded factors that evaluated whether the property was intended to be sold “tocustomers in the ordinary course of business.” The Court further noted that the exceptionenumerated in Sec. 1031(a), I.R.C. relating to property held primarily for sale is broader than theexception to capital gain treatment in Sec. 1221(1), I.R.C. The standards are not one and thesame. The Court then turned to an analysis of the taxpayer’s intent in holding the property,noting that NTB’s intent as of the time of the exchange was controlling. Eline Realty Co. v.Comm’r, 35 T.C. 1, 5 (1960). After an exhaustive analysis of the facts surrounding the holdingof the property, the Court concluded that NTB did not meet its “burden of proving that when itwas dealing with the Exchange Property it was wearing the hat of an investor”, and, therefore,Sec. 1031, I.R.C. did not apply. NTB did not help its case by listing on its tax returns “real estatesubdivider and developer” as the company’s principal business activity, and classifying theproperty as inventory on its financial statements.

(2) Similarly, in Chief Counsel Advice 201025049 (March 12,2010), the Service provided guidance on whether a corporation could treat certain equipment that

-5-

was simultaneously held for sale to customers and designated as rental equipment as like-kindexchange property. In this Advice, a corporation purchased certain equipment from amanufacturer and designated certain pieces of the equipment as rental equipment, which itdepreciated under Sec. 167, I.R.C.. When such equipment was rented, the corporation enteredinto a rental agreement which provided the renter with the right to buy the rented equipment.Specifically, the corporation negotiated the sale with the customer and assigned the sales contractto a qualified intermediary. Then, the corporation ordered replacement property from themanufacturer and assigned the rights to acquire the equipment to the qualified intermediary. Thereplacement property was assigned an order number and was entered into the corporation’s fixedasset depreciation system. For the fiscal year at issue, 91% of the corporation’s income wasgenerated from “sales”, while only 9% was generated from its rental operations. In addition,approximately 40% of the replacement property was disposed of in the year it was acquired, withnearly 50% being disposed of within 90 days. Because a substantial amount of the designatedrental equipment was sold soon after its acquisition, the Service held that the equipment was notheld for the production of rental income, but instead should be treated as inventory heldprimarily for sale to customers in the ordinary course of business. Consequently, the propertycould not satisfy the requirements of Sec. 1031, I.R.C. (or Sec. 167, I.R.C.).

(3) But see Paullus v. Comm’r, 72 TCM 636 (1996), where theCourt held that real estate owned by a corporation for four years was not “dealer property”, eventhough the taxpayer obtained residential zoning for the property and maintained an office forpurposes of selling individual lots.

h. Where dealer property is exchanged, the Service has stated that thetransactions may be taxable as to the dealer in the exchange, but nonetheless tax-free as to theother party. See Rev. Rul. 77-297, 1977-2 C.B. 304.

i. Where dealer property is incidental to real estate, the entire transfermay qualify for Sec. 1031, I.R.C. deferral. See, e.g., Beeler v. Comm’r, 75 TCM 1699 (1998),holding that, entire gain was deferred where the primary purpose for holding land was forpossible expansion of a mobile home park and mining sand was merely an incidental activity.Cf. Watson v. Comm’r, 345 U.S. 544 (1953) (purchase was primarily of orange groves, not realestate).

2. Definition of “Solely” -- The word “solely” does not mean that a taxpayerwho receives non-like kind property in the exchange is entirely outside Sec. 1031, I.R.C. Thetransaction will be taxable to the extent that a taxpayer receives non-like kind property (“boot”).Sec. 1031(d), I.R.C.

3. Held for Use in a Trade or Business or for Investment

a. Property held for productive use in a trade or business mayproperly be exchanged for investment property under Sec. 1031, I.R.C. Reg. §1.1031(a)-1(a)(1).

-6-

b. It is recommended that property be held for productive use in atrade or business or for investment purposes during at least 2 taxable years before a like kindexchange is attempted.

c. Vacation Homes --

(1) In Moore v. Comm’r, T.C. Memo 2007-134, for the firsttime, the Tax Court considered the application of Sec. 1031, I.R.C. to vacation homes. The factsin that case were fairly typical. The Moores purchased vacation property that they never rented(or attempted to rent). Several years later, they decided to sell their first vacation home andpurchase another as a replacement property. The Moores alleged that the principal reason theyheld both vacation properties was the potential appreciation. Accordingly, they claimed that theexchange qualified for Sec. 1031, I.R.C. nonrecognition treatment, as both properties were heldfor investment. The Court denied Sec. 1031, I.R.C. treatment on the exchange, based on the factthat the Moores never held the homes out for rent or primarily for sale at profit, only put onehome up for sale out of need for liquidity, claimed no maintenance or depreciation expensedeductions, treated all interest expenses as personal mortgage interest, and admittedly allowedone home to fall into disrepair once they stopped using it regularly.

(2) After the decision in Moore, the Treasury InspectorGeneral for Tax Administration issued a report urging the Service to provide guidance on thetreatment of vacation homes under Sec. 1031, I.R.C. In response, the Service issued Rev. Proc.2008-16, 2008-10 I.R.B. 547, in which the Service held that it will not challenge whether adwelling unit (including a vacation home) will qualify as property held for investment orproductive use in a trade or business if the following requirements are met:

(a) For relinquished property, the taxpayer must ownthe dwelling unit for at least 24 months before the exchange, and in each of the two 12-monthperiods preceding the exchange, the taxpayer must rent the dwelling unit at fair rental for at least14 days, and the period of the taxpayer’s use may not exceed the greater of 14 days or 10 percentof the number of days during that 12-month period that the dwelling unit is rented at a fair price.

(b) For replacement property, it must meet the samerequirements as relinquished property, except that the testing periods are the months after theexchange.

(3) In Goolsby v. Comm’r, T.C. Memo 2010-64, taxpayersexchanged a residence held as investment property for another residence (the “replacementproperty”) and claimed that the exchange qualified for nonrecognition treatment under Sec.1031, I.R.C. However, the Court did not agree, based on the facts that:

(a) The taxpayers moved into the replacement propertyand used it as a personal residence within 2 months after they acquired it;

(b) The purchase of the replacement property wascontingent on the sale of their former personal residence;

-7-

(c) Before the Sec. 1031, I.R.C. exchange, thetaxpayers sought advice from the QI regarding whether they could move into the replacementproperty if no renters were found;

(d) The taxpayers failed to research whether thehomeowners’ association would allow the rental of the replacement property; and

(e) The taxpayers failed to research rental opportunitiesin the area of the replacement property.

d. Transfer to a Corporation -- The Service has held that theprearranged transfer by an individual of land and buildings used in his trade or business to anunrelated corporation in exchange for land and an office building, followed by the immediatetransfer of such property received to the individual’s newly formed corporation in a Sec. 351,I.R.C. transaction, does not qualify as an exchange under Sec. 1031(a), I.R.C. Rev. Rul. 75-292,1975-2 C.B. 333.

(1) The rationale for this conclusion was that the propertyreceived was not held for investment or for productive use in a trade or business, but rather forimmediate transfer to a corporation.

(2) The same result was reached in Regals Realty Co. v.Comm’r, 127 F.2d 931 (CA2 1942), where property received in an exchange by a parentcorporation and immediately transferred to its subsidiary was held not to be a Sec. 1031, I.R.C.exchange of like kind property.

e. Transfer from a Corporation -- Property received in a corporateliquidation may be viewed as “held” for investment if the taxpayer did not formulate the intent toexchange the property until after the liquidation occurred.

(1) In Bolker v. Comm’r, 81 T.C. 782 (1983), aff’d 760 F.2d1039 (CA9 1985), the Ninth Circuit permitted the taxpayer nonrecognition treatment for theexchange of land received in a former Sec. 333, I.R.C. liquidation for like kind property. Theissue was whether the taxpayer actually “held” the property for investment prior to the exchangeas required by Sec. 1031(a), I.R.C.

(2) In affirming the Tax Court, the Ninth Circuit distinguishedRev. Ruls. 77-337, 1977-2 C.B. 304 and 77-297, 1977-2 C.B. 305, by noting that the liquidationwas in fact planned before any intention to exchange the property arose and that the taxpayeractually held the property for three months prior to the exchange. The Ninth Circuit found thatthe “holding” requirement of Sec. 1031(a), I.R.C. was satisfied if the taxpayer owned propertyand did not intend to liquidate it or use it for personal pursuits.

(3) See also Maloney v. Comm’r, 93 T.C. 89 (1989), holdingthat the acquired property was not liquidated in the sense of being cashed out, but rather that the

-8-

taxpayers continued to have an economic interest in essentially the same investment, althoughthere was a change in the form of ownership.

(4) See also Priv. Ltr. Rul. 9252001 (September 12, 1992),where the Service ruled that the receipt of like kind real property by a surviving corporationfollowing a merger in exchange for property transferred by a predecessor corporation prior to themerger qualified for nonrecognition of gain treatment, since the taxpayer did not “cash in” on theinvestment in the relinquished property.

f. Transfer to a Partnership -- In Magneson v. Comm’r, 81 T.C. 767(1983), aff’d 753 F.2d 1490 (CA9 1985), the taxpayer traded a fee simple interest in acommercial property for an undivided 10% interest in another commercial property, and on thesame day contributed that 10% interest and cash to a partnership for a 10% general partnershipinterest therein.

(1) Effectively denying viability to Rev. Rul. 75-292, 1975-2C.B. 333, the Court, noting that the receipt of the partnership interest was tax free under Sec.721, I.R.C., held the like kind exchange to be good because the taxpayers “merely effected achange in the form of the ownership of their investment instead of liquidating their investment”.

(2) In affirming the decision of the Tax Court, the NinthCircuit noted that, in order to qualify under Sec. 1031(a), I.R.C., the taxpayer must intend, at thetime the exchange is effectuated, to hold the acquired property for investment. Magneson v.Comm’r, 753 F.2d 1490, 1493 (CA9 1985).

(a) The issue was whether contributing property to apartnership in return for a general partnership interest was “holding” the property for investmentwithin the meaning of Sec. 1031(a), I.R.C.

(b) The Ninth Circuit sought to distinguish Rev. Rul.75-292 by pointing out that (i) a corporation is a distinct entity, while a partnership is anassociation of its partners/investors, and (ii) at the time of this exchange Sec. 1031(a), I.R.C.expressly excluded exchanges of stock, but had no such prohibition for partnership interests.

g. Transfer from a Partnership --

(1) In Crenshaw v. U.S., 450 F.2d 472 (CA5 1971), cert.denied, 408 U.S. 923 (1972), the taxpayer liquidated her investment in a partnership, receivingan undivided interest in the partnership’s primary asset, an apartment building. She thenexchanged this interest for a shopping center held in her husband’s estate. The estate sold theinterest in the apartment building to a corporation owned by her former partners. The FifthCircuit held that the taxpayer was not entitled to nonrecognition treatment because she engagedin all of the steps to avoid the taxable sale of her partnership interest to her former partners.

-9-

(2) See F.S.A. 199951004 (September 3, 1999). The taxpayerwas a partnership that owned real property with rights to acquire adjacent property. Thetaxpayer and an individual formed a joint venture in order to construct, develop and operate twobuildings. Subsequently, the two parties decided to dissolve the venture and distribute the assets.The individual had made additional capital contributions and owned a 75 percent interest in theventure at the time of the dissolution. The venture was originally treated as a partnership forFederal income tax purposes until the parties filed an election under Sec. 761, I.R.C. concurrentwith the dissolution to treat their percentage interests in the venture as interests in each of theassets. The taxpayer had owned a 25 percent interest in the venture and purported to transfer a25 percent interest in each of the two buildings to the individual. In exchange for its 25 percentinterest in each building, the taxpayer received consideration from the individual in the form ofdebt relief for the taxpayer’s share of liabilities attributable to each building. The taxpayertransferred its 25 percent interest in each of the two buildings to a qualified intermediary (“QI”),and the QI transferred the interests in the properties to the individual. The taxpayer entered intotwo separate exchange agreements in which the taxpayer agreed to identify and acquirereplacement property within the statutory time period. The taxpayer attempted to treat thetransfer of the interest in the properties as an exchange under Sec. 1031, I.R.C. However, theService determined that the transaction was in substance a sale by the taxpayer of its 25 percentinterest in the joint venture to the individual. Consequently, Sec. 1031, I.R.C. did not apply, andthe taxpayer was not entitled to nonrecognition treatment on the sale of the 25 percent interest inthe joint venture.

h. Transfer of Property to an LLC Treated as a Disregarded EntityPrior to Sec. 1031, I.R.C. Exchange -- In two private letter rulings, the Service ruled that thedisregarded character of such single-member LLCs will be respected for Sec. 1031, I.R.C.exchange purposes. Priv. Ltr. Rul. 9807013 (November 13, 1997) and Priv. Ltr. Rul. 9751012(September 15, 1997).

(1) In these rulings, Sec. 1031, I.R.C. exchange treatment wasaccorded to a transfer of relinquished property by the sole owner of the single-memberdisregarded entity LLC in exchange for replacement property received by such disregardedentity. The Service concluded that, because the single-owner LLC is disregarded as an entity,the transactions in question would be viewed as if the taxpayer itself had directly received thereplacement property, therefore satisfying the holding requirement of Sec. 1031, I.R.C.

(2) The same result will ensue when an LLC is formed afterdisposition, but prior to acquisition of replacement property. See Priv. Ltr. Rul. 9911033(December 18, 1998) (LLC formed at insistence of lender financing acquisition of replacementproperty); and Priv. Ltr. Rul. 9850001 (August 31, 1998) (transfer of replacement property toLLC formed after disposition).

(3) In Priv. Ltr. Rul. 200131014 (August 6, 2001), the taxpayertransferred two hotel properties into two separate wholly owned LLCs after receiving the hotelproperties as replacement properties in a like kind exchange. Because the LLCs would bedisregarded and the taxpayer considered the direct owner of the hotel properties, the Service held

-10-

that the hotel properties would be considered held for productive use in a trade or business or forinvestment. See also Priv. Ltr. Rul. 200732012 (May 11, 2007).

(4) See Priv. Ltr. Rul. 200118023 (January 31, 2001), wherethe taxpayer’s QI was a single member LLC with disregarded entity status for Federal incometax purposes. The taxpayer proposed to acquire the single member LLC as replacement propertyin a like kind exchange transaction. The QI acquired real property selected by the taxpayer. TheQI had constructed improvements on the real property that it acquired. The direct transfer of thereal property to the taxpayer would have been subject to a real estate transfer fee under state law.However, the transfer of the interest in the single member LLC would not be subject to the realestate transfer fee. The taxpayer’s receipt of the LLC interest was treated as the direct receipt ofthe real property owned by the LLC for purposes of Sec. 1031, I.R.C.

(5) See also Priv. Ltr. Rul. 199911033 (December 18, 1998),wherein a grantor trust formed an LLC in order to effectuate a like kind exchange of realproperty. The trust was treated as the sole owner of the LLC. The Service ruled that thereplacement property was acquired directly by the trust for purposes of Sec. 1031(a)(3), I.R.C.

i. Exchange Followed by Liquidation or Reorganization --

(1) Corporation -- In Priv. Ltr. Rul. 9850001 (August 31,1998), T, a 100% owned subsidiary of H, held hotel property for productive use in a trade orbusiness (the relinquished property). On a timely basis, T transferred the relinquished propertyto a QI, identified like kind replacement property and directed that the replacement property betransferred to LLC2, a wholly owned limited liability company and a disregarded entity.

The parties contemplated that, shortly thereafter, T would liquidate into H (its parentcorporation), under Sec. 332, I.R.C., and that H would merge into S, in an “A” reorganizationunder Sec. 368(a)(l)(A), I.R.C. S is the sole owner of LLC1, a limited liability company, and adisregarded entity for tax purposes. As a result of the merger, S would be the sole owner ofLLC1 and LLC2, which would retain their character as disregarded entities. It was thencontemplated that S would transfer its interest in LLC2 to LLC1, with both continuing inexistence. The taxpayer requested a ruling that the liquidation of T into H and the merger of Hand S would not affect the holding period requirement under Sec. 1031(a)(l), I.R.C. that thereplacement property be held for either productive use in a trade or business or investment. Inmaking its determination, the Service considered the legislative history and case law that havedeveloped under Sec. 1031, I.R.C. The Service articulated two major rationales for Sec. 1031,I.R.C.: (1) that nonrecognition treatment should lie where the taxpayer received like kindproperty because he has not “cashed out” of his investment; and (2) that requiring sale orexchange treatment in this context would create administrative burdens with respect to valuingsuch replacement property. See Starker v. United States, 602 F.2d 1341, 1352 (CA9 1979).

The Service concluded that these concerns are equally applicable where, as here, as aresult of a Sec. 332, I.R.C. liquidation or a Sec. 368(a)(1)(A), I.R.C. reorganization, a successorcorporation obtains ownership of like kind property previously received by a liquidated or anacquired corporation in a transaction to which Sec. 1031, I.R.C. would otherwise apply. In other

-11-

words, the intended intervening liquidation and reorganization had no effect on the requirementthat the replacement property be held by the taxpayer or whether the replacement property washeld for the productive use of a trade or business or for investment. Thus, a liquidation orreorganization subsequent to a good Sec. 1031 transaction, under these facts, will not operate topreclude nonrecognition treatment.

(2) Partnership / LLC --

(a) In Priv. Ltr. Rul. 199935065 (May 28, 1999), two Scorporations owned more than 95 percent of the membership interests in two LLCs. The twoLLCs each owned and operated one hotel property. The LLCs planned to dispose of the hotelproperties and to acquire resort-like hotels in a like kind exchange transaction. Prior to the datewhen the companies would receive the replacement properties, the LLCs liquidated andtransferred all of the assets to the members. The members immediately contributed the assetsfrom the LLC in formation of new limited partnerships. The new limited partnerships wereformed to prevent a carryover of liabilities to the replacement properties from the LLCs whichtransferred the relinquished properties. The lenders required the limited partnerships acquiringthe replacement properties to be separate and apart from the owners of the relinquishedproperties to prevent such transfer of liabilities. The Service ruled that the conversion of the twoLLCs into limited partnerships would not result in a termination of the entities under Sec. 708,I.R.C. The limited partnerships were considered as a continuation of the LLCs. The Service alsodetermined that the limited partnerships would be treated as both the transferors of therelinquished properties and the transferees of the replacement properties for purposes of Sec.1031(a), I.R.C. The Service did not conclude whether the transaction would definitely qualifyfor nonrecognition treatment under Sec. 1031, I.R.C.

(b) In Priv. Ltr. Rul. 200812012 (December 19, 2007),a trust and its wholly owned corporation together owned an LLC. The real estate investmentactivities conducted by the LLC included like kind exchanges of real estate investmentproperties. In furtherance of a reverse like kind exchange under Rev. Proc. 2002-37, 2002-2C.B. 308, the LLC had acquired a replacement property and was going to dispose of relinquishedproperty that it held. In the meantime, pursuant to the terms of the will that created the trust, thetrustees developed a plan of termination for the trust, including the formation of an entity thatwould own the LLC and the wholly owned corporation. The Service explained that the plan oftermination would result in a deemed termination of the LLC under Sec. 708(b)(1)(B), I.R.C.,meaning that, under Rev. Rul. 99-5, 1999-1 C.B. 434, the LLC would be deemed to contribute itsassets to a new entity in exchange for interests in that entity. The LLC’s assets would continueto be held for investment or productive use in a trade or business under Sec. 1031(a), I.R.C.regardless of the deemed termination. The Service stated that the like kind exchange wasindependent of the termination and that the termination would not affect the exchange.

(3) Trust --

(a) In Priv. Ltr. Rul. 200651030 (September 19, 2006),a testamentary trust with assets consisting primarily of real estate holdings was due to terminate.

-12-

With prior probate court approval, the trust had diversified its holdings over many years througha series of like kind exchanges.

(b) Pursuant to the trust’s plan of termination, the trustwould distribute cash to some beneficiaries and an in-kind distribution to one beneficiary. Therest of the trust corpus would be transferred to an LLC with the trust as its sole member. Upontermination of the trust, the LLC interests would be distributed among the remainingbeneficiaries. Following the trust’s termination, the members of the LLC would be almostidentical to the trust’s beneficiaries, and the managerial and operational structure would remainin place in the LLC. The LLC would also continue the business practices of the trust, includingits practice of diversifying its holdings through like kind exchanges. At issue in this ruling weretwo like kind exchanges that the trust would start prior to its termination and the LLC wouldconclude (within the appropriate time period for a deferred exchange) following the trust’stermination.

(c) The Service found that the exchanges were acontinuing practice of the trust and were independent of the trust’s termination. Since thetermination was involuntary, and since the LLC would conduct essentially the same business asthe trust, the Service concluded that the transfer of the relinquished properties by the trust to theLLC, subject to contracts for disposition by the LLC, would not violate the holding requirementof Sec. 1031, I.R.C. Consequently, both exchanges, completed with the purchase of replacementproperties by the LLC through a qualified intermediary, would qualify as deferred like kindexchanges.

j. Gifts -- The fact that a taxpayer intends eventually to make a giftof the property received in a like kind exchange does not prevent Sec. 1031, I.R.C. fromapplying based on the theory that the property will not be held for investment.

(1) In Wagensen v. Comm’r, 74 T.C. 653 (1980), the taxpayerwas found to have acquired like kind property even though, at the time of the exchange, heintended eventually to give the acquired property to his children, and in fact did so 10 monthslater. In the Court’s view, to hold otherwise would have elevated form over substance. TheCourt noted that, if the taxpayer had given his property to his children, and they made the trade,it would have been a like kind exchange as to them. See also Priv. Ltr. Rul. 8429039 (April 17,1984) (trade of a beach house for a personal residence to be rented for at least two years after theexchange qualified for tax-free treatment).

(2) Nonetheless, taxpayers should be sure not to make a gift ofthe property received in a like kind transaction immediately after the exchange, particularly if therecipients intend to use the property for personal purposes, rather than for investment or use in atrade or business. Nonrecognition treatment is not accorded to the extent property is held forpersonal use. See Click v. Comm’r, 78 T.C. 225 (1982), where the taxpayer did not qualify fornonrecognition treatment because her children moved into the acquired residential properties onthe date of the exchange and taxpayer gifted the properties to them seven months later.

-13-

k. Decedent as Transferor of Relinquished Property -- Any proceedsfrom the like kind exchange of two properties will not give rise to income in respect of adecedent under Sec. 691, I.R.C.

(1) In Priv. Ltr. Rul. 9829025 (April 17, 1998), a husband anda wife, who lived in a community property jurisdiction, transferred two parcels of real estate to agrantor trust. The husband and wife, as trustees of the trust, entered into a separate like kindexchange agreement with a bank and separately sold each of the two properties. On thehusband’s date of death, the trustees had identified and entered into a contract to purchasereplacement property for one of the properties, but not the other.

(2) The Service concluded that, inasmuch as the exchangequalified for nonrecognition treatment under Sec. 1031, I.R.C., the proceeds from the exchangeattributable to the husband’s interest in the properties are not treated as an item of income inrespect of a decedent. The surviving spouse was entitled to a step up in basis for the entireinterest in both properties under Sec. 1014, I.R.C.

4. Mandatory Applicability -- The application of Sec. 1031, I.R.C. ismandatory rather than elective. Thus, if a taxpayer has any favorable reason to recognize gain orloss, the transaction should not be structured to qualify under Sec. 1031, I.R.C.

5. Definition of Like Kind -- The term “like kind” refers to the nature orcharacter of property (for example, real property vs. personal property), as opposed to its qualityor grade. Reg. §1.1031(a)-1(b). See Peabody Natural Res. Co. v. Comm’r, 126 T.C. 261 (2006)(holding the exchange of operating gold mines for operating coal mines subject to two coalsupply contracts to be of like kind); Priv. Ltr. Rul. 200035005 (May 11, 2000) (exchange of FCCradio station license for FCC television station license qualified as like kind property based oncharacter of property rather than quality or grade); and Priv. Ltr. Rul. 200912004 (December 2,2008) (concluding that cars, light-duty trucks, and crossover vehicles are similar in nature orcharacter and, thus, are considered like kind property).

6. Personal Property -- Treatment as Like Kind

a. Generally, personal property of a particular class may not beexchanged in a nonrecognition transaction for personal property of a different class. The Servicerecently modified the Regulations, effective for transfers on or after August 12, 2004, thatreplace the use of the Standard Industrial Classification (“SIC”) system with the North AmericanIndustry Classification System (“NAICS”) for determining what personal properties are of likeclass for purposes of Sec. 1031. The new Regulations generally incorporate the formerprovisions of Reg. § 1.1031(a)-2(b)(3) (prior to Amendment by T.D. 9202 (May 18, 2005))relating to the use of product classes but substitute NAICS codes for SIC codes. Reg.§ 1.1031(a)-2(b)(3). The new Regulations omit the provisions of former Reg. § 1.1031(a)-2(b)(4) that permit taxpayers to rely on modifications to the general asset classes in Rev. Proc.87-56, 1987-2 C.B. 674, for purposes of structuring like kind exchanges.

-14-

b. Depreciable tangible personal property will be of a like kind orclass, if the properties are within the same General Asset Class, as determined under certainSections of Rev. Proc. 87-56, 1987-2 C.B. 674, or the properties are within the six-digit productclass of the NAICS. Reg. §1.1031(a)-2(b). But see Priv. Ltr. Rul. 200912004 (December 2,2008), where the fact that cars and light-duty trucks were not of the same General Asset Classdid not preclude the Service from treating such properties as like kind property for Sec. 1031,I.R.C. purposes because they were of a like kind nature or character.

c. See Tech. Adv. Memo. 200035005 (September 1, 2000). Thetaxpayer corporation transferred an FCC license to several radio stations in exchange for alicense to a television station. The asset exchange agreement also provided for the transfer oftangible personal property including radio and television broadcasting equipment. The Serviceconcluded that the exchange of an FCC radio license for a television license qualified as a likekind exchange within the meaning of Sec. 1031, I.R.C., because the nature and the character ofthe rights involved in the two licenses were comparable under Reg. § 1.1031(a)-2(c)(3). See alsoPriv. Ltr. Rul. 200532008 (May 9, 2005) (concluding that the taxpayer’s exchange of FCClicenses for spectrum rights in the Ww and Xx bandwidths for FCC licenses for spectrum rightsin the Xx bandwidth and Yy bandwidth would qualify as a like kind exchange under Sec. 1031,I.R.C.).

d. In Tech. Adv. Memo. 200224004 (June 14, 2002), the Servicefound that the assigned frequency of the electromagnetic spectrum referred to in a televisionlicense is the sole underlying property to which a television license relates for purposes of thenonrecognition rules under Sec. 1031, I.R.C. The Service rejected the taxpayer’s assertion thatthe ability to affiliate with a major television network is part of the underlying property to whichthe license relates. This technical advice memorandum did not alter the Service’s earlierconclusion in Tech. Adv. Mem. 200035005 that a taxpayer’s exchange of FCC radio licenses foran FCC television license qualified as a like kind exchange.

e. See F.S.A. 199951006 (September 10, 1999). The taxpayercorporation and its subsidiary owned certain property to be relinquished in an asset exchangetransaction. The property to be relinquished included land with improvements, computerequipment, patents and patent applications associated with facilities, and tradenames, trademarksand service marks associated with the facilities. The taxpayer and its subsidiary entered into anexchange agreement with another parent corporation and a subsidiary corporation utilizing a QI.The taxpayer’s transfer of the relinquished property also included the transfer of goodwill. Thetaxpayer corporation identified replacement property within the required statutory period.

The Service focused on the coordination between Secs. 1031 and 1060, I.R.C. TheService determined that the exchange of the relinquished property was intended to be a sale of anongoing business based on the terms of the asset purchase agreement between the parties. TheService concluded that Reg. § 1.1031(a)-2(c)(2) governs for purposes of determining whethergoodwill or going concern value constitutes like kind property. Specifically, Reg. § 1.1031(a)-2(c)(2) provides that the goodwill or going concern value of a business is not of a like kind to thegoodwill or going concern value of another business.

-15-

f. See Tech. Adv. Memo. 200602034 (September 29, 2005), in whichthe taxpayer entered into four transactions during the year involving the transfer and acquisitionof tangible and intangible business assets. The intangible assets consisted of patents, trademarksand trade names, designs and drawings, software and trade secrets. On its corporate income taxreturn, the taxpayer treated the transactions involving the intangible assets as tax-deferred likekind exchanges under Sec. 1031, I.R.C. Whether intangible personal property is of a like kind toother intangible personal property generally depends on (i) the nature or character of the rightsinvolved (e.g., patent or copyright) and (ii) the nature or character of the underlying property towhich the intangible property relates. See Reg. § 1.1031(a)-2(c)(1).

(1) Patents -- With respect to the patents in this case, thetaxpayer and the Service agreed that the first prong of the two-part test in Reg. § 1.1031(a)-2(c)(1) was satisfied because the patent rights are like kind. However, as for the underlyingproperty, the taxpayer and the Service offered competing views as to the proper analysis. Thetaxpayer suggested dividing the patents into the following four broad classes of underlyingproperty based on patent law -- process, machine, manufacture and composition of matter. TheService flatly rejected this methodology as having no basis in the law and applied the NAICSproduct codes and the General Asset Class classification system to determine whether theunderlying property was of like kind.

(2) Trademarks and Trade Names -- The Service concludedthat none of the trademarks and trade names exchanged were of a like kind because they were allcomponents of a larger asset, either goodwill or going concern or both. Cf. Chief CounselAdvice 200911006 (Feb. 12, 2009).

(3) Unregistered Intellectual Property -- Applying the two-partanalysis of Reg. § 1.1031(a)-2(c)(1), the Service concluded that the proprietary informationexchanged by the taxpayer (e.g., designs and drawings, trade secrets and secret know-how, andsoftware) satisfied the first prong of the test. The taxpayer and the Service disagreed again withrespect to the application of the second test. Here, the taxpayer suggested that the proprietaryinformation be grouped in the same categories set forth in the Uniform Trade Secrets Act (i.e., aformula, pattern, compilation, program, device, method, technique or process). The Service alsorejected the taxpayer’s suggested groupings of the unregistered intellectual property andconcluded that such property is not like kind unless the specific underlying properties to whichthe unregistered intangibles relate are within the same General Asset Class or the same ProductClass.

(4) Foreign Intangibles -- The Service rejected the taxpayer’sargument that Sec. 1031(h)(2), I.R.C. which provides that personal property used predominantlyin the U.S. and personal property used predominantly outside the U.S. are not like kind property,does not apply to intangible property. The Service observed that Sec. 1031(h)(2), I.R.C. makesno distinction between tangible and intangible personal property. In the alternative, the taxpayerargued that the predominant use of the intangibles was in the U.S. because a U.S. subsidiarymanaged the licensing of the relinquished intangibles and would also manage the licensing of thereplacement intangibles. The Service also rejected this argument on the basis that intangibleassets are used in the jurisdiction whether they are enjoyed. Put another way, the jurisdiction in

-16-

which the intangible is licensed to be used is the jurisdiction of use even if the management ofthe licensing process is based in another jurisdiction.

g. See Chief Counsel Advice 200911006 (February 12, 2009), wherethe Chief Counsel reversed the Service’s course of treatment and concluded that intangibles,including mastheads, trademarks, trade names and customer-based intangibles, that can beseparately described and valued apart from goodwill qualify as like kind property under Sec.1031, I.R.C.

h. See Rev. Proc. 92-91, 1999-2 C.B. 503, in which the Service heldthat emission allowances, regardless of the year to which the allowances are allocated by theEPA, are treated as like kind property for purposes of Sec. 1031, I.R.C. As a result, an exchangeof emission allowances that would otherwise be a taxable event under Sec. 1001, I.R.C. willqualify for nonrecognition treatment under Sec. 1031, assuming all of the other requirements aresatisfied. An interesting question is whether a disposition of an allowance pursuant to theproposed cap-and-trade program proposed in the American Clean Energy and Security Act of2009, H.R. 2454, can be structured as part of a like kind exchange.

7. Real Property -- Treatment as Like Kind

a. Real Property -- Defined

(1) State law is the general determinant of what constitutes realproperty.

(a) An illustration of the impact of state law is found inOregon Lumber Co. v. Comm’r, 20 T.C. 192 (1953), holding that, where the right to cut timberwas an interest in personalty under Oregon state law, the exchange of land for the same did notqualify for like kind treatment under Sec. 1031, I.R.C. See also Priv. Ltr. Rul. 200424001(December 8, 2003) (holding that components of railroad track that are assembled and attachedto the land and considered real property for state law purposes are not like kind to unassembledand unattached components considered personal property under applicable state law); and Priv.Ltr. Rul. 200404044 (October 23, 2003) (concluding that, because the taxpayer’s water rightswere consider a perpetual interest in real property under applicable state law, the proposedexchange of the water rights for a fee simple interest in farmland qualified as a like kindexchange).

(b) Nevertheless, state law will not always govern, suchas where the exchanged interest is considered as real property under state law but is treated as aright to future income for Federal income tax purposes. See, e.g., Comm’r v. P. G. Lake, Inc.,356 U.S. 260 (1958). See also Coupe v. Comm’r, 52 T.C. 394 (1969), holding that thetaxpayers’ rights under the sales contract were choses in action, and that a subsequent exchangeof those rights for real property did not qualify as a like kind exchange under Sec. 1031, I.R.C.

(2) A land lease of 30 years or longer is treated as theequivalent of an interest in land and therefore should qualify in a like kind exchange under Sec.

-17-

1031, I.R.C. See Reg. §1.1031(a)-1(c); Rev. Rul. 60-43, 1960-1 C.B. 687; and Rev. Rul. 76-301,1976-2 C.B. 241. See also Priv. Ltr. Rul. 8304022 (October 22, 1982).

(3) See Priv. Ltr. Rul. 200631012 (April 13, 2006), holdingthat the exchange by two taxpayers of shares of a New York cooperative housing corporation forboth improved and unimproved real properties, which they intended to own as tenants-in-common, was a good like kind exchange. The Service first resolved that, whether stock in acooperative housing corporation in New York State constitutes real or personal property for Sec.1031, I.R.C. purposes, is determined under New York law. The Service then determined that theapplicable New York law treats an interest in a cooperative housing corporation as equivalent toa real property interest.

(4) See Priv. Ltr. Rul. 200137032 (June 15, 2001), holding thatthe exchange of shares and a proprietary lease of a New York cooperative housing corporationfor a condominium deed was a good like kind exchange. The Service noted that there was someambiguity as to whether the cooperative shares were real property under New York law, but heldthat the weight of authority was to such effect.

(5) See Priv. Ltr. Rul. 200901020 (October 1, 2008), holdingthat residential density development rights were of like kind to a fee interest in real estate, aleasehold interest in real estate with 30 years or more remaining at the time of the exchange andland use rights for hotel unit. This conclusion was based on the fact that the development rightswould be in perpetuity, were directly related and requisite to the taxpayer’s interest in theunderlying land and were interests in real property under state law.

b. The fact that one property may be developed completely while theother is raw land will not preclude like kind treatment. Reg. §1.1031(a)-1(b).

c. It may be logically thought that real property exchanged for realproperty will always qualify for “like kind” treatment. As a warning, however, it should benoted that the Service has ruled, in connection with Sec. 1033(g), I.R.C., that, although the term“real estate” is often used to embrace both land and improvements thereon, land andimprovements are by nature not alike merely because one term is used to describe both. Rev.Rul. 67-255, 1967-2 C.B. 270; Rev. Rul. 64-237, 1964-2 C.B. 319; Rev. Rul. 76-390, 1976-2C.B. 243.

(1) The relationship of Secs. 1031, 1033(a) and 1033(g), I.R.C.can be summarized as follows:

(a) Sec. 1031, I.R.C. applies only to property (both realand personal) held for productive use in a trade or business or for investment when such propertyis exchanged for property of a like kind to be held either for productive use in a trade or businessor for investment.

(b) Sec. 1033(a), I.R.C. is dissimilar in its requirementthat the properties involved in the conversion be “similar or related in service or use”.

-18-

(c) A special rule is found in Sec. 1033(g), I.R.C.which applies solely to real property. This provision allows the nonrecognition provisions ofSec. 1033(a), I.R.C. to apply if the proceeds from a conversion of real property held forproductive use in a trade or business or for investment are reinvested in property of a like kind tobe held either for productive use in a trade or business or for investment.

(2) It is evident that the standards of Secs. 1031 and 1033(g),I.R.C. are, or at the least should be, virtually identical regarding real property. Consequently,interpretations of Secs. 1031 and 1033(g), I.R.C. should be equally illustrative in determiningwhat does or does not qualify as real property of a like kind for purposes of these two Sections.However, in this regard, in the context of Sec. 1033(g), I.R.C., see Rev. Rul. 67-255, 1967-2C.B. 270; Rev. Rul. 71-41, 1971-1 C.B. 223; and Priv. Ltr. Rul. 9118007 (January 30, 1991).These all reflect the unwillingness of the Service to allow a taxpayer to utilize Sec. 1033(g)where land is involuntarily converted, but the reacquisition does not include land.

(3) Sec. 1033(a), I.R.C. provides that, at the election of thetaxpayer, gain is recognized to the extent the amount realized from a conversion exceeds the costof the replacement property. A partnership (or a limited liability company treated as apartnership for Federal income tax purposes), rather than the individual partners (or members, asthe case may be), is required to make the election not to recognize gain under Sec. 1033, I.R.C.Similar rules apply to S corporations.

(4) See Priv. Ltr. Rul. 199907029 (September 30, 1998),where four individuals contributed cash and an apartment building in the formation of aresidential real estate venture. Subsequently, the individuals entered into a partnershipagreement that allocated profits and losses with respect to the venture. The venture, determinedto be a partnership for Federal income tax purposes, obtained financing and constructed a secondapartment building. A natural disaster destroyed the first apartment building and the fourindividuals received cash from the filing of their insurance claims. Three of the partners usedtheir proportionate share of the insurance proceeds to purchase another apartment buildingintended to qualify as replacement property under Sec. 1033, I.R.C. The purchase price of thereplacement property exceeded the gain realized by the three individuals from the conversion.Consequently, the partnership qualified for the deferral of gain from the conversion under Sec.1033, I.R.C. The Service allowed the election under Sec. 1033, I.R.C. of the first partnershipconsisting of all four partners to apply with respect to the continuation of such partnership withthe three remaining partners.

d. Unproductive real estate, held by a non-dealer for future use or forfuture realization of the increment in value, is property held for investment and not heldprimarily for sale. Reg. §1.1031(a)-1(b).

e. Under Sec. 1031(h), I.R.C., real property located in the UnitedStates and real property located outside the United States are not like kind. Under Sec.7701(a)(9), I.R.C., the term “United States”, when used in the geographic sense, includes onlythe states and the District of Columbia. This would mean that the Virgin Islands, Guam and

-19-

Puerto Rico are considered to be outside the United States. However, real property located in theVirgin Islands will be considered as located within the United States for purposes of Sec. 1031,I.R.C. to the extent that Sec. 932, I.R.C. applies. Section 932, I.R.C. will apply if the taxpayerinvolved in the exchange is a citizen or resident of the United States and has income derivedfrom sources within the Virgin Islands. Section 932, I.R.C. will also apply if the taxpayer hasincome effectively connected with the conduct of a trade or business within the Virgin Islands orif the taxpayer files a joint tax return with an individual who meets the applicable requirementsfor the taxable year of the exchange. See Priv. Ltr. Rul. 200040017 (June 30, 2000), holding thatthe Virgin Islands are included within the United States; and Priv. Ltr. Rul. 9038030 (June 25,1990).

f. Trusts and Conservation Easements

(1) Delaware Statutory Trust -- Prior to the issuance of Rev.Rul. 2004-86, 2004-2 C.B. 191, the Delaware statutory trust (“DST”) had been viewed aspotentially the ideal entity through which multiple owners of a single piece of real property couldhold the property, as opposed to through a tenancy-in-common arrangement. It was unclear,however, whether an exchange of interests in a DST would qualify for nonrecognition treatmentunder Sec. 1031, I.R.C.

In response to inquiries from tax practitioners, the Service issued Rev. Rul. 2004-86,which involved a highly factual, and arguably unrealistic scenario, in which the powers of a DSTtrustee were limited to the mere collection and distribution of income. In light of these limitedpowers, the Service concluded that the DST in this case was an investment trust whose interestscould be exchanged for real property in a like kind exchange. Although the narrowness of thisRuling may have disappointed many tax practitioners who had hoped for the ability to use DSTsmore broadly, the Ruling nevertheless did provide useful guidance concerning grantor trusts. Inclassifying the DST in the Ruling as a grantor trust, the implication was that an exchange of realproperty for interests in a grantor trust that holds real property qualifies for nonrecognition underSec. 1031, I.R.C.

Importantly, the Service stated the DST in Rev. Rul. 2004-86 would have been classifiedas a business entity, rather than an investment trust, and thus would not be eligible for like kindtreatment if the trustee had been given the power to do one or more of the following:

(a) dispose of the contributed property and acquire newproperty;

(b) renegotiate the lease with the original tenant orenter into leases with new tenants;

(c) renegotiate or refinance the obligation used topurchase the property;

(d) invest cash received to profit from marketfluctuations; or

-20-

(e) make more than minor non-structural modificationsto the property.

(2) Illinois Land Trust -- In Rev. Rul. 92-105, 1992-2 C.B.204, the Service held that a taxpayer’s interest in an Illinois land trust (or other similararrangement) constituted real property and therefore could be exchanged for like kind property.Rev. Rul. 92-105 concluded that, because the trustee’s only responsibility was to hold andtransfer title at the direction of the taxpayer, a trust relationship was not established,notwithstanding the land trust agreement accompanying the taxpayer’s contribution of the land tothe entity. Further, there were no other arrangements between the taxpayer and the trustee thatwould have caused the overall arrangement to be classified as a partnership. The Serviceconcluded that the trustee was a mere agent for the holding and transfer of title to real property,and so the taxpayer retained direct ownership of the real property for Federal income taxpurposes.

In Rev. Rul. 2004-86, the Service distinguished Rev. Rul. 92-105 on two grounds. First,the beneficiary in Rev. Rul. 92-105 retained the direct obligation to pay the liabilities and taxesrelating to the property held in trust; in contrast, in Rev. Rul. 2004-86, Delaware law providesthe beneficial owners of a DST with limited personal liability. Second, unlike the taxpayer thatcontributed the real property to the DST in Rev. Rul. 2004-86, the beneficiary in Rev. Rul. 92-105 retained the right to manage and control the trust.

(3) Conservation Easements -- In Priv. Ltr. Rul. 9851039(September 15, 1998), the Service concluded that an exchange of an agricultural conservationeasement, which is considered as an interest in land under applicable state law, for a fee simpleinterest in land qualified for nonrecognition under Sec. 1031(a), I.R.C. See also Priv. Ltr. Rul.200201007 (October 2, 2001) (holding likewise).

B. Exchanges

1. An exchange is a reciprocal transfer of property, as opposed to a sale ofproperty for consideration and a purchase reinvestment. See Reg. §1.1002-1(d). Substance willprevail over form.

2. A transaction couched in terms of an exchange may be deemed a sale. InCarlton v. United States, 385 F.2d 238 (CA5 1967), the taxpayers agreed to sell their ranch undera contract giving them the option either to receive cash or to find other real property and requirethe purchaser to exchange it for their ranch. The purchaser entered into contracts to purchase thereplacement property, but at closing the purchaser assigned the contracts of purchase plus thecash to the taxpayers, who then paid the sellers of the replacement property. The Court foundthat an exchange did not occur because the taxpayers received cash.

3. The purchase of one property and the subsequent sale of another are twoseparate transfers that do not constitute an exchange. A sale for cash is not an exchange even ifthe cash is immediately reinvested in like kind property. See, e.g., Lincoln v. Comm’r, 76 TCM926 (1998), citing Coastal Terminals, Inc. v. United States, 320 F.2d 333, 337 (CA4 1963).

-21-

4. The Service may also recharacterize an exchange transaction as a salebased on the view that a series of steps actually constitutes integrated steps in a singletransaction. See Smith v. Comm’r, 537 F.2d 972 (CA8 1976), where the Court found that three“separate” transactions constituted steps in one transaction, thereby holding that a sale tookplace. But see Biggs v. Comm’r, 69 T.C. 905 (1978), aff’d 632 F.2d 1171 (CA5 1980); andBoise Cascade Corp. v. Comm’r, 33 TCM 1443 (1974).

5. By contrast, the Service may treat what is in form two sales as anexchange, especially to the extent that a loss is disallowed. In Allegheny County Auto Mart, Inc.v. Comm’r, 12 TCM 427 (1953), the taxpayer purchased real property that did not accommodatethe taxpayer’s used car business. Two weeks later, in what appeared on its face to be a separatetransaction, the taxpayer arranged to purchase a larger lot from the owner and sell him therecently acquired property as partial consideration. The Court viewed these transfers as part of asingle transaction for tax purposes, an exchange instead of two sales, and disallowed recognitionof the loss incurred by the taxpayer.

6. The trade of real property for the construction of a building to thetaxpayer’s specifications may be treated as either a sale or an exchange, depending on whoseland such building is constructed.

a. If the taxpayer owns the land used in the transferee’s constructionof the building, then the transaction is considered as a sale rather than as an exchange. Thetransaction constitutes a sale because there is no exchange of like kind property. The transfereeprovides services (the construction of improvements) in exchange for the real property receivedfrom the transferor. See Bloomington Coca-Cola Bottling Co. v. Comm’r, 189 F.2d 14 (CA71951). See also Priv. Ltr. Rul. 9031015 (May 4, 1990), ruling that the use of proceeds from thesale of rental houses to construct an apartment building for the seller on land he already owneddid not qualify as a like kind exchange. But see Priv. Ltr. Rul. 8847042 (August 26, 1988).

b. However, if the transferee owns the land on which the building isconstructed and then transfers the land and the building, there will be a qualifying like kindexchange. See J. H. Baird Publishing Co. v. Comm’r, 39 T.C. 608 (1962).

c. See also Rev. Rul. 75-291, 1975-2 C.B. 332, where X exchangedland and a factory used by X in its manufacturing operations for land acquired and a factoryconstructed on it by Y solely for the purpose of the exchange with X. The Service ruled that thetransaction qualified as a like kind exchange as to X but not as to Y. Nonrecognition treatmentwas not accorded to Y because it acquired the property transferred to X immediately prior to theexchange, and constructed the factory for purposes of the exchange, so that it did not hold suchproperty for productive use in its trade or business or for investment. See also Priv. Ltr. Rul.7929091 (April 23, 1979), where it was noted that the building would be constructed by anotherparty according to plans and specifications approved by the taxpayer, solely for purposes of atrade with the taxpayer. See, likewise, Priv. Ltr. Rul. 9149018 (September 4, 1991).

7. A transaction qualifies as a like kind exchange under Sec. 1031, I.R.C.only to the extent the taxpayer who sells the relinquished property also receives replacement

-22-

property. In the partnership context, this means that, where property being relinquished is heldby the partnership, the reciprocal transfer of replacement property must be received by thepartnership, not deeded directly to the partners. Priv. Ltr. Rul. 9818003 (December 24, 1997).The Service emphasized that, although the seller of the replacement property need not have titleto the replacement property (see Rev. Rul. 90-34, 1990-1 C.B. 154), the seller of the relinquishedproperty must take legal title to the replacement property.

8. Taxpayers seeking to exchange relinquished MACRS property forreplacement MACRS property must be aware of the general rule of Reg. § 1.168(i)-6, whichprovides that the exchanged basis is depreciated over the remaining recovery period of, andusing the depreciation method and convention of, the relinquished MACRS property.

a. Exchanged basis is determined after the depreciation deduction forthe year of disposition is determined and is the lesser of—(i) the basis in the replacementMACRS property, as determined under Sec. 1031(d), I.R.C. and the Regulations under Sec.1031(d), I.R.C. or (ii) the adjusted depreciable basis (as defined in Reg. §1.168(b)-1(a)(4)) of therelinquished MACRS property.

b. The general rule applies if the replacement property has the sameor shorter recovery period or the same or more accelerated depreciation method than therelinquished property. Reg. § 1.168(i)-6(c)(4).

9. Taxpayers seeking to exchange real estate which has been depreciated, inwhole or in part, via accelerated depreciation (generally, realty placed in service prior to 1987),must be wary of the recapture provisions of Secs. 1245 and 1250, I.R.C. Typically, the recapturewill be triggered only where the taxpayer’s real estate is exchanged for unimproved land, whichis deemed nondepreciable realty. (Revenue Act of 1964, Pub. L. No. 88-272, H. Rep. No. 88-749, 1964-1 (Part 2) C.B. 123, 230.) Generally, the amount subject to recapture, and taxed asordinary income, is the lesser of excess depreciation claimed or the amount of gain realized.(See Sec. 1250(a), I.R.C. for special rules.) However, if the taxpayer’s real estate is commercialproperty, the entire amount of depreciation taken may be recaptured. This is becausecommercial property placed in service after 1980 and before 1987, and depreciated by anaccelerated method, may be considered Sec. 1245, I.R.C. property. (Former Sec. 1245(a)(5),I.R.C., prior to repeal by Sec. 201(d)(11) of the Tax Reform Act of 1986, Pub. L. No. 99-514,99th Cong., 2d Sess., approved October 22, 1986), effective generally for property placed inservice after 1986, in tax years ending after 1986.) Under Sec. 1245(a), I.R.C., all depreciationclaimed is recaptured as ordinary income upon disposition, up to the gain realized in thetransaction. Thus, it is advisable to proceed with extreme caution any time a taxpayer plans todispose of realty that has been written off via accelerated depreciation.

C. Designations of Replacement Property -- Generally

1. Generally, a property owner may require a would-be purchaser to acquireother property to exchange for the owner’s property solely in order to effectuate a tax-freeexchange rather than a sale. See, e.g., Rev. Rul. 77-297, 1977-2 C.B. 304.

-23-

2. For example, in Alderson v. Comm’r, 317 F.2d 790 (CA9 1963), the Courtheld that it was acceptable to allow the taxpayers to amend an executed sales contract to convertthe transaction into an exchange for purposes of Sec. 1031, I.R.C. See also Coupe v. Comm’r,52 T.C. 394 (1969); Borchard v. Comm’r, 24 TCM 1643 (1965); and Rev. Rul. 75-291, 1975-2C.B. 332. But see Estate of Bowers v. Comm’r, 94 T.C. 582 (1990), where substantialimplementation of the sale before restructuring as an exchange cast the transaction as a sale.

3. In Mercantile Trust Company of Baltimore, Executors v. Comm’r, 32B.T.A. 82 (1935), the purchaser had an option to buy the property for cash or to exchangeproperty, and this was held acceptable as an exchange.

4. As the Tax Court held in another case, “[o]f crucial importance in such anexchange is the requirement that title to the parcel transferred by the taxpayer in fact betransferred in consideration for property received.” Coupe v. Comm’r, 52 T.C. 394, at 405(1969). See also Rutland v. Comm’r, 36 TCM 40 (1977).

5. See Priv. Ltr. Rul. 8852031 (September 29, 1988), where the Service ruledthat a good like kind exchange may result notwithstanding the fact that the exchangor does nothave title to the property exchanged. The exchanging party proposed to have third partiesconvey certain properties directly to the taxpayer in order to avoid the possibility of doubletaxation from the transfer. The Service relied on W.D. Haden Co. v. Comm’r, 165 F.2d 588(CA5 1948).

6. An interesting approach was used in 124 Front Street, Inc. v. Comm’r, 65T.C. 6 (1975), a case in which the taxpayer owned an option to acquire property that theFireman’s Fund Insurance Company wanted to purchase. Fireman’s advanced the taxpayer thefunds to purchase the property. Subsequently, the taxpayer exchanged such property for otherproperty acquired by Fireman’s for purposes of the exchange.

a. The Tax Court held that the transaction was a valid like kindexchange, and that the loan, which was bona fide, was not boot to the taxpayer. Note that theCourt emphasized the documentation and form, which the Court stated was “consistent with theintent of the parties”.

b. The 124 Front Street case was followed in Biggs v. Comm’r, 69T.C. 905 (1978), aff’d 632 F.2d 1171 (CA5 1980), which found for the taxpayer in a factualsituation in which the taxpayer advanced the funds that ultimately enabled the other party to theexchange to acquire the property needed for the exchange.

-24-

III. EXCHANGES WITH BOOT

A. Generally

1. “Boot” is cash or other property not falling in the tax-free category.

a. Generally, the transfer by the taxpayer of qualified property forlike kind property plus cash or other property will result in the transaction being only partiallytax-free. Sec. 1031(b), I.R.C. provides:

“If an exchange would be within the provisions of subsection (a), ofsection 1035(a), of section 1036(a), or of section 1037(a), if it were not forthe fact that the property received in exchange consists not only ofproperty permitted by such provisions to be received without therecognition of gain, but also of other property or money, then the gain, ifany, to the recipient shall be recognized, but in an amount not in excess ofthe sum of such money and the fair market value of such other property.”

b. If the fair market value of the like kind property plus the cash orother property (“boot”) received is greater than the basis of the property transferred, then gainwill be realized. Such gain is recognized to the extent of the cash plus other non-like kindproperty received, valued at its fair market value. See Leach v. Comm’r, 91 F.2d 551 (CA61937) for a simple illustration of Sec. 1031(b), I.R.C. in operation. See Priv. Ltr. Rul.200901004 (September 29, 2008), holding that a matching-up of like kind properties may causegain recognition, even though no cash is received, if the fair market values are not equal.

2. Where the boot exceeds the gain, such excess reduces the basis of the likekind property acquired in the exchange.

3. If other non-cash property is received in the exchange, the basis isallocated first to the “boot” property to the extent of its fair market value. Reg. §1.1031(d)-1(c).

a. Any remainder is then allocated to the property acquired. Thisallocating mechanism does not affect the gain computation.

b. EXAMPLE: A transfers real property with a value of $315,000and a basis of $250,000 to B in exchange for real property worth $300,000, a car worth $5,000and $10,000 in cash. The gain realized by A is $65,000, which is recognized only to the extentof $15,000. A’s basis for the property received is $255,000 ($250,000, less $10,000 cashreceived, plus the $15,000 gain recognized). This $255,000 is allocated $5,000 to the car and$250,000 to the new real property.

c. In transactions that involve boot, gain recognized will not exceedthe amount received as boot, except to the extent depreciation recapture may occur.

-25-

4. If the value of the like kind property plus the cash or other property(“boot”) received is less than the basis of the property transferred, then no loss is recognized.Sec. 1031(c), I.R.C.

a. Instead, the receipt of boot causes the basis of the like kindproperty received to be reduced.

b. EXAMPLE: If, in the above example, A’s original basis had been$350,000, with a $315,000 value, A would now hold the car and the real property with a totalbasis of $340,000 ($350,000, less $10,000 cash received, there being no gain recognized). This$340,000 would be allocated $5,000 to the car and $335,000 to the land. See Reg.§1.1031(d)-1(d).

5. Section 1250(d)(4), I.R.C. provides a limitation on the amount of gainrecognized under Sec. 1250(a), I.R.C. where gain is not recognized in whole or in part under Sec.1031, I.R.C. The general rule under Sec. 1250(d)(4), I.R.C. is that ordinary income is notrecognized under Sec. 1250, I.R.C. where no boot is received, unless the amount of any Sec.1250, I.R.C. gain (which would have been recognized if Sec. 1031, I.R.C. did not apply) exceedsthe fair market value of Sec. 1250, I.R.C. property acquired. See Sec. 1250, I.R.C.; Reg.§1.1250-3(d).

a. EXAMPLE: A building held for the production of income is traded forraw land, to be held for investment. There is $20,000 in recapturable depreciation attributable tothe building, but raw land does not constitute Sec. 1250, I.R.C. property, because it is notdepreciable. Accordingly, there is $20,000 of ordinary income recognized on the exchange.

b. If, on the other hand, there were a building with a fair market value ofat least $20,000 on the land, there would be no recognition of ordinary income on the exchange.

6. For certain depreciable business assets, the original use of whichcommences with the taxpayer after December 31, 2007, are acquired by the taxpayer afterDecember 31, 2007 and before January 1, 2010, and are placed in service in 2009 or 2010,taxpayers may claim an additional first-year write-off of 50% of the cost of such assets. See Sec.168(k), I.R.C. This additional depreciation, however, is limited in the case of a like kindexchange. Only the amount of money the acquirer pays for the replacement property (i.e., bootin the hands of the recipient) is eligible for the additional first-year write off. See Reg.§ 1.168(k)-1(f)(5). Consequently, taxpayers contemplating the replacement of a depreciableasset worth less than its tax basis should consider selling the asset outright in a taxabletransaction rather than entering a like kind exchange to replace the asset. The taxpayer can usethe sales proceeds to purchase the replacement asset. Under this scenario, the seller mayrecognize the loss on the sale and benefit from the additional depreciation deduction based on thereplacement asset’s full cost.

-26-

B. The Impact of Mortgages

1. Where mortgages appear on only one side of the transaction, two generalrules govern.

a. First, if the transferor transfers property subject to a mortgage,whether or not the transferee assumes the debt, the amount of the liability is treated as moneyreceived by the transferor for purposes of adjusting the basis under Sec. 1031(d), I.R.C. SeeReg. §l.1031(d)-2. The Regulations provide that the amount of the liability is to be treated asmoney received by the taxpayer in the exchange, regardless of whether the assumption resultedin the recognition of gain or loss to the taxpayer. Section 1031(d), I.R.C. exclusively governs thetax treatment of mortgages assumed or property taken subject to by the exchanging parties.Consequently, the boot provisions of Sec. 1031(b), I.R.C. do not apply. See Rev. Rul. 59-229,1959-2 C.B. 180; Reg. §1.1031(a)-1.

b. Second, if the transferor acquires property subject to a mortgage,or assumes the debt, his basis for the new property is increased.

c. EXAMPLE: A transfers an apartment house with a fair marketvalue of $1,600,000 and a basis of $1,000,000 and subject to a $300,000 mortgage to B for anapartment house worth $1,300,000 and a basis to B of $800,000. The tax consequences to A areas follows: the realized gain is $600,000 ($1,300,000 value of B’s property, plus $300,000liability to which A’s property is subject, less $1,000,000 basis of A’s property). A’s recognizedgain is $300,000, the amount of the mortgage. A’s basis is $1,000,000 ($1,000,000 less$300,000 liability plus $300,000 gain recognized). The tax consequences as to B are: a realizedgain of $500,000 ($1,600,000 value of A’s property, less $300,000 liability to which A’sproperty is subject, less $800,000 basis of B’s property). B recognizes no gain and his basis is$1,100,000 ($800,000 plus $300,000).

2. A netting rule applies to the extent that the relinquished property and thereplacement property are subject to mortgages or if debt is assumed by the transferee. Thisnetting feature with like kind exchanges is generally favorable in managing distressed propertyforeclosures and workouts. Reg. §1.1031(d)-2.

a. The transferor of the property encumbered by the larger mortgageis treated as having received cash in an amount equal to the excess of the mortgage on theproperty transferred over the mortgage on the property received. However, if the taxpayer alsotransfers cash or other boot, the excess mortgage liability is reduced to the extent of the cash orfair market value of the other boot transferred. Reg. §1.1031(d)-2. See Blatt v. Comm’r, 67TCM 2125 (1994).

b. The impact of such an exchange potentially may have an adverseimpact on the transferee, who still receives boot, because the receipt of cash or other boot(including promissory notes) is not offset by any excess of the mortgage on the property receivedover the mortgage on the property transferred. See Coleman v. Comm’r, 180 F.2d 758 (CA81950).

-27-

c. The issue becomes to what extent may the transferor and transfereeadjust the level of their mortgages through refinancings prior to the exchange to minimize theirboot issues.

(1) The transferee could increase the amount of the mortgageprior to the exchange, if practicable, to receive cash and in that way equalize the mortgages, thusassisting both the transferor and the transferee. See Fredericks v. Comm’r, 67 TCM 2005(1994).

(a) However, pre-exchange financing will beconsidered boot when the refinancing is an integral part of the exchange. See Long v. Comm’r,77 T.C. 1045 (1981); and Simon v. Comm’r, 32 T.C. 935 (1959), aff’d 285 F.2d 422 (CA31960).

(b) In Prop. Reg. §1.1031(b)-1(c), it was provided thatthe netting concept “shall not apply to the extent of any liabilities incurred by the taxpayer inanticipation of an exchange” under Sec. 1031, I.R.C. The problem was that the phrase “inanticipation of” was, at best, ambiguous. Did it mean “as a step in the transaction”, or “within ashort period before the transaction”, or “at any time prior to an exchange if the taxpayercontemplates making an exchange at any time in the future”? Due to a hue and cry from the realestate industry, this Proposed Regulation was dropped.

(2) A more conservative plan would be for the transferor to paydown the mortgage prior to the exchange, again in order to equalize the mortgages on both sides.

(3) EXAMPLE: A transfers property with a fair market valueof $200,000, subject to a $100,000 mortgage and with a $100,000 basis to B for like kindproperty with a $200,000 fair market value, subject to a $150,000 mortgage and $50,000 in cash.B’s basis is $100,000. As to B, the gain realized is $100,000 ($200,000 fair market value ofproperty received less $100,000 mortgage less zero basis (arrived at by $100,000 plus $50,000,less $150,000)). B recognizes no gain. As to A, the gain realized equals $100,000 ($200,000fair market value of the property received plus $100,000 mortgage given up plus $50,000 cashreceived, less $150,000 mortgage received, less the basis of $100,000). A will recognize gainbecause he must treat the $50,000 cash received as boot. He should have increased his mortgageor insisted, if possible, that B pay down his mortgage. A could have refinanced post-exchangeon a tax-free basis had B paid down the mortgage.

d. In many exchanges, the taxpayer will use proceeds received fromthe disposition of the transferred property to satisfy the mortgage and then borrow to finance theacquisition of the replacement property. This should constitute mortgage netting even thoughthere is technically no assumption of or transfer subject to debt. See Barker v. Comm’r, 74 T.C.555 (1980). See Priv. Ltr. Rul. 8003004 (September 19, 1979), where taxpayer is allowed to payoff transferee’s mortgage and refinance with new debt and have mortgage netting apply. Seealso Priv. Ltr. Rul. 9853028 (September 30, 1998) (mortgage on transferred property may benetted with debt incurred to purchase acquired property).

-28-

e. See Rev. Rul. 2003-56, 2003-23 C.B. 985, in which the Serviceaddressed the question of whether liabilities are netted for purposes of Sec. 752, I.R.C. when apartnership enters into a deferred like kind exchange under Sec. 1031, I.R.C. straddling twotaxable years. In Situation 1 of the Ruling, a partnership started a deferred like kind exchange inyear 1 by disposing of relinquished property with a value of $300x and subject to a liability of$100x. In year 2, the partnership (within the applicable time requirements) acquired replacementproperty with a value of $260x and subject to a liability of $60x. In Situation 2 of the Ruling, thesame facts applied except that the replacement property had a value of $340x and was subject toa liability of $140x. The Service applied the liability offsetting rule in the Regulations underSec. 1031, I.R.C. in determining whether any deemed distributions occurred for Sec. 752, I.R.C.purposes. Accordingly, in both situations, the partners of the partnership were entitled to net theliability on the replacement property against the liability on the relinquished property indetermining their consequences under Sec. 752, I.R.C. As a result, the partners of thepartnership experienced a deemed distribution under Sec. 752, I.R.C. in Situation 1 ($100xliability on relinquished property offset only to the extent of the $60x liability on the replacementproperty); however, they received no deemed distribution and, therefore, recognized no incomeor gain under Situation 2 ($100x liability on relinquished property fully offset by $140x liabilityon the replacement property). The Service also stated that a similar analysis would apply indetermining reductions of partnership minimum gain.

f. See Priv. Ltr. Rul. 200019014 (February 10, 2000), wherein thetaxpayers were six state limited partnerships with the same general and limited partners. Thegeneral partner in the partnerships was a state business corporation. The partnerships owned realproperties which included mobile home park improvements. The taxpayers proposed to enterinto a tax-free forward deferred exchange transaction with a QI. The relinquished propertieswould be transferred to the QI, which would sell such properties and retain the proceeds. Thetransaction would be structured so that the taxpayers’ right to receive the proceeds from the saleof the relinquished properties would be limited to the permissible circumstances described inReg. § 1.1031(k)-1(g)(6). Subsequently, the intermediary would acquire replacement propertiesselected by the taxpayers within the required statutory period and transfer such properties to thetaxpayers. The taxpayers intended that the replacement properties would consist of apartmentcomplexes in which each partnership owned an undivided interest as tenant in common. Thetaxpayers had refinanced nonrecourse mortgages to which the relinquished properties weresubject. A portion of the proceeds of the refinancing was distributed to the partners. Thepartners used the distributed proceeds from the refinancing to purchase more properties. Thetaxpayers represented in the transaction that the aggregate amount of mortgages on thereplacement properties would exceed or equal the amount of mortgages on the relinquishedproperties.

The Service concluded that the transaction qualified as a deferred like kind exchangerather than a sale of the properties. The transfer of the fee simple interests in the real propertyand the mobile home park improvements in exchange for undivided interests in other real andpersonal property qualified for nonrecognition treatment under Sec. 1031, I.R.C. The Servicedetermined that the proceeds from the refinancing of the mortgages on the relinquishedproperties would not be considered as payments of boot in the deferred exchange transaction.

-29-

The refinancing had economic significance independent of the proposed exchange. Thetaxpayers received lower interest rates on the loans, and the proceeds from the refinancing wereused to purchase more properties (a legitimate business reason). The Service concluded that thetaxpayers will not recognize any gain or loss in the exchange of the relinquished properties forthe replacement properties, except to the extent that the sum of the proceeds from therelinquished properties and the amount of the refinanced debt exceeds the purchase price of thereplacement properties.

C. Installment Sales

1. The taxpayer may elect the installment method of reporting taxable gainon the exchange if the requirements of Sec. 453, I.R.C. are met. Generally, Sec. 453, I.R.C.allows taxpayers to allocate the gain or loss recognized on the disposition of property over theterm of the installment obligation. The amount of tax imposed is paid per installment accordingto the allocation formula set forth in Sec. 453(b)(2), I.R.C. This general rule is subject to theoverriding provisions of Sec. 453(i), I.R.C. which govern the recognition of recapture incomeunder Secs. 1245 and 1250, I.R.C. with respect to an installment obligation. See Rev. Rul.65-155, 1965-1 C.B. 356, and Priv. Ltr. Rul. 8453034 (September 28, 1984).

a. According to Sec. 453(f)(6), I.R.C., the gain is generallyrecognized ratably as the taxpayer is paid during the term of the installment note.

b. Specifically, the Regulations provide that, if the taxpayer’s basisexceeds the fair market value of the like kind property received, that excess constitutes “excessbasis”. Prop. Reg. §1.453-1(f)(1)(iii).

2. The exchange is treated as if the taxpayer had made an installment sale ofappreciated property, with a basis equal to the “excess basis”, in which the considerationreceived comprises the installment obligation and any other boot. Prop. Reg. §1.453-1(f)(1)(iii).

a. The selling price is the sum of the face value of the installmentobligation (reduced in accordance with the original issue discount rules), any net qualifyingindebtedness, net cash received and the fair market value of any boot.

b. The total contract price is the selling price less any net qualifyingindebtedness that does not exceed the excess basis.

c. Finally, payment in the year of exchange includes any netqualifying indebtedness that exceeds the excess basis.

d. EXAMPLE: In 2010, A makes a Sec. 1031(b), I.R.C. exchange of realproperty held for investment with a basis of $400,000 and subject to a $200,000 mortgage forpermitted property worth $200,000, and a $600,000 installment obligation issued by the otherparty to the exchange bearing adequate stated interest. The permitted property received by A inthe exchange is not subject to a mortgage. A is treated as having sold the property for $600,000cash and $200,000 net relief of mortgage liability. The $200,000 mortgage liability of which A

-30-

is deemed relieved is treated as qualifying indebtedness. Since the qualifying indebtedness($200,000) does not exceed A’s basis of $200,000, B’s taking subject to such indebtedness doesnot constitute payment to A in the year of exchange. Under the installment method, the sellingprice is $800,000 and the total contract price is $600,000 (selling price of $800,000 less$200,000 of qualifying indebtedness that does not exceed A’s basis). Gross profit is also$600,000 ($800,000 selling price less $200,000 excess basis), and the gross profit ratio is 1($600,000/$600,000). A recognizes no gain until payments are received on the installmentobligation. As A receives payment (exclusive of interest) on the $600,000 installment obligation,the full amount received will be gain attributable to the exchange. A holds the permittedproperty with a basis of $200,000. Prop. Reg. §1.453-1(f)(1)(iv), Ex. 3.

IV. EXCHANGES BETWEEN RELATED PERSONS -- TRIGGERING DEFERREDGAIN

A. Background

1. Congress was concerned that taxpayers were able to defer taxable gainthrough the use of certain shifts in basis among related taxpayers. For example, assume that twowholly owned subsidiaries of a holding company own parcels of undeveloped real estate. Parcel1 (in the hands of Corporation X) has an adjusted basis of $100,000 and Parcel 2 (in the hands ofCorporation Y) has an adjusted basis of $800,000. An unrelated party, Corporation T, wishes tobuy Parcel 1 for $900,000. If Corporation X sells Parcel 1, it will have a gain of $800,000($900,000 less $100,000). However, if Corporation X and Corporation Y first trade their parcelsunder Sec. 1031, I.R.C., then Corporation Y will own Parcel 1 with an adjusted basis of$800,000, and thus, on sale, will have a gain of only $100,000 ($900,000 less $800,000).

2. The Service could have challenged this trade as beyond the scope of Sec.1031(a), I.R.C. in all events based on the theory that Corporation Y did not acquire Parcel 1 forholding for productive use in a trade or business or for investment. See, e.g., Regals Realty Co.v. Comm’r, 127 F.2d 931 (CA2 1942); and Rev. Rul. 75-292, 1975-2 C.B. 333.

3. However, in order to solve this problem, Sec. 1031(f), I.R.C. and Sec.1031(g), I.R.C. were added to the Code.

B. General Rules

1. A special rule under Sec. 1031(f), I.R.C. governs exchanges betweenrelated persons. Specifically, nonrecognition treatment is not available to the extent that (i) thetaxpayer exchanges property with a related person; (ii) nonrecognition treatment wouldotherwise apply outside the scope of Sec. 1031(f), I.R.C.; and (iii) either the related party or thetaxpayer disposes of the property within two years of the date of the exchange. The term“related person” is defined according to Secs. 267(b) or 707(b)(1), I.R.C. for purposes of Sec.1031, I.R.C. See Priv. Ltr. Rul. 199926045 (April 2, 1999) (taxpayer attributed more than 50percent ownership in holding company with voting and nonvoting common stock owned by sonand through trust). See also F.S.A. 200137003 (May 10, 2001) (related party rule did not

-31-

preclude nonrecognition treatment where subsequent disposition occurred more than two yearsafter the date of the exchange).

a. Section 1031(f)(1), I.R.C. provides that a taxpayer’s gain or lossrecognized in a like kind exchange with a related party is taken into account on the date of asubsequent transfer of the exchanged property.

(1) Note that any amount of loss may be limited by the relatedparty rules of Sec. 267, I.R.C.

(2) Nonrecognition treatment within the scope of Sec. 1031,I.R.C. does not apply to any exchange which is part of a transaction (or series of transactions)structured to avoid the related party limitation provided in Sec. 1031(f), I.R.C. See, e.g., Priv.Ltr. Rul. 9748006 (August 25, 1997), in which the Service concluded that a taxpayer was notentitled to nonrecognition treatment because the taxpayer’s mother was involved in themultiparty exchange, in a clear attempt to disguise the related-party nature of the underlyingtransaction.

(3) S. Rep. No. 1750, 101st Cong., 1st Sess. 206-207 (1989),points out, as an avoidance technique, the use of the unrelated third party as an intermediary. Forexample, using Corporations X, Y and T as described above, Corporation Y would first sellParcel 2 to Corporation T, recognizing the $100,000 profit on sale, and Corporation T wouldthen, within two years, trade Parcel 2 with Corporation X for Parcel 1. See Rev. Rul. 2002-83,2002-2 C.B. 927 (discussed below).

b. In Priv. Ltr. Rul. 9609016 (November 22, 1995), the taxpayerproposed to exchange his undivided interests in 23 separate parcels of farm land (which heowned with five related persons) for a 100% interest in three of the 23 parcels. The taxpayerrepresented to the Service that the owners of the 23 parcels would not dispose of their interests(other than by reason of death) during the two-year period following the exchange. The Serviceruled that the exchange would qualify under Sec. 1031, I.R.C.

c. The two-year period is suspended during any portion thereof thatthe holder’s risk of loss as to the property is substantially diminished by (i) the holding of a putwith respect to such property; (ii) the holding by another person of a right to acquire suchproperty; or (iii) a short sale or any other transaction. Sec. 1031(g), I.R.C.

C. Exceptions (Certain Dispositions Not Taken into Account)

1. A disposition will not trigger recognition if it occurs:

a. After the earlier of the death of the taxpayer or the death of therelated person (Sec. 1031(f)(2)(A), I.R.C.); or

-32-

b. In a compulsory or involuntary conversion (under Sec. 1033,I.R.C.) if the exchange occurred before the threat or imminence of such conversion. Sec.1031(f)(2)(B), I.R.C.

2. A disposition also will not trigger recognition if it is established thatneither the exchange nor such disposition had as one of its principal purposes the avoidance ofFederal income tax. Sec. 1031(f)(2)(C), I.R.C.

a. The Senate Finance Committee Report indicates that this exceptiongenerally is intended to apply to transactions that do not involve the shifting of basis betweenproperties (the exchange of high basis property for low basis property in anticipation of sellingthe low basis property). See S. Rep. No. 1750, 101st Cong., 1st Sess. 206-207 (1989).

(1) In Priv. Ltr. Rul. 200706001 (October 31, 2006), theService concluded that shifting basis between family members in anticipation of a sale was not aprimary purpose of an exchange, between related parties, of parcels of land with (i) equal valueand (ii) the same per acre basis.

(2) The Service did not find a shifting of basis between relatedparties in anticipation of the sale of a low basis property when the taxpayer acquired replacementproperty from an unrelated third party through a qualified intermediary, even though a relatedparty bought the relinquished property, through the qualified intermediary, with the intent to sellthe relinquished property within two years. See Priv. Ltr. Rul. 200709036 (November 28, 2006)(dealing with a deferred like kind exchange); and Priv. Ltr. Ruls. 200712013 (November 20,2006) and 200728008 (April 12, 2007) (each dealing with a reverse like kind exchange).

b. This exception also applies to the following:

(1) In Priv. Ltr. Rul. 200616005 (December 22, 2005), Trustand S Corp, related persons within the meaning of Sec. 1031(f)(3), I.R.C., owned Building 1 andBuilding 2, respectively. Trust transferred Building 1 to Buyer and desired to defer therecognition of gain on this transfer through the acquisition of Building 2 from S Corp in a likekind exchange. S Corp, in turn, intended to acquire replacement property for Building 2 in atransaction also intended to qualify for nonrecognition under Sec. 1031, I.R.C. To facilitatethese exchanges, Trust and S Corp planned to enter into exchange agreements with a qualifiedintermediary. Both Trust and S Corp represented that they would not dispose of their respectivereplacement properties within two years of receipt. Based on these facts and representations, theService ruled that Sec. 1031(f)(4), I.R.C. and Rev. Rul. 2002-83, 2002-2 C.B. 927 (discussedbelow), were not applicable because there was no “cashing out” of either party’s investment inreal estate.

(2) In Priv. Ltr. Rul. 200440002 (October 1, 2004), the Serviceclarified the circumstances under which related parties can engage in a like kind exchangethrough a qualified intermediary without triggering gain pursuant to Sec. 1031(f), I.R.C. Theruling involved two related partnerships (“Partnership 1” and “Partnership 2”), each of whichengaged in a like kind exchange through a QI. The replacement property for Partnership 1’s

-33-

exchange was to be the property that Partnership 2 relinquished in its exchange, and thereplacement property for Partnership 2’s exchange was to be acquired from a third party. TheService contrasted the facts of this ruling with the facts of Rev. Rul. 2002-83. Because here bothrelated parties ended up with like kind property, and not cash, the Service held that Sec. 1031(f),I.R.C. would not apply. See also Priv. Ltr. Ruls. 200810016 and 200810017 (both December 6,2007) (similar fact patterns and conclusions, but related parties were LLCs treated as partnershipfor Federal income tax purposes).

(3) In Priv. Ltr. Rul. 200440002 (June 14, 2004), the Serviceconcluded that Sec. 1031(f), I.R.C. did not apply to back-to-back like kind exchanges involvingrelated partnerships because the partnership that received its replacement property from therelated party stipulated that it would not dispose of the replacement property within the two-yearperiod following its receipt of the property.

(4) In Priv. Ltr. Rul. 199926045 (April 2, 1999), the Serviceheld that a transaction involving an exchange of undivided interests in different properties thatresults in each taxpayer holding either the entire interest in a single property or a largerundivided interest in any of such properties qualifies as a like kind exchange.

(5) In Priv. Ltr. Ruls. 200920032 and 200919027 (bothFebruary 3, 2009), a parcel of farmland was owned by a father. Upon the father’s death, it wasplaced into two testamentary trusts with income payable to the mother for life and the remainderto their three children (A, B and C). Upon the death of the mother, the farmland was transferredto the three children as tenants in common. Each child subsequently deeded his/her interest to agrantor trust (Trust A, Trust B and Trust C) . C subsequently died. Pursuant to the terms ofTrust C, C’s interest in farmland was to remain in trust with the trust income to be paid to hersurviving spouse for life and the remainder to her children. Trust C wished to liquidate itsownership interest in farmland. A and B (the “Taxpayers”) wished to remain invested infarmland. The Trusts agreed to exchange each of their undivided one-third (1/3) interest in theentire parcel of farmland for 100 percent fee simple interest in a one-third (1/3) portion of thesame property. This division would split farmland into three parcels of equal value. The issueraised was whether the exchange would qualify for tax-free treatment, even though Trust Cplanned to sell the property within two years. The Service stated that Trust C and the Taxpayerswere not related parties under Sec. 1031(f)(1), I.R.C. inasmuch as the Taxpayers and the trusteesof Trust C (child C’s spouse and children) were not related. Thus, the later sale by Trust C of itsfee simple interest in a portion of the farmland was not a transaction to which Sec. 1031(f),I.R.C. applied. Accordingly, the non-recognition treatment of the exchange was not affected byTrust C’s sale.

D. Treatment of Certain Transactions

1. Section 1031(f)(4), I.R.C. sets forth a tax avoidance provision so thatnonrecognition treatment under Sec. 1031, I.R.C. does not apply to any exchange which is partof a transaction (or series of transactions) structured to avoid the related party limitations underSec. 1031(f), I.R.C.

-34-

2. In Rev. Rul. 2002-83, 2002-2 C.B. 927, the Service concluded that ataxpayer who transferred relinquished property to a QI in exchange for replacement propertyformerly owned by a related party was not entitled to nonrecognition treatment under Sec.1031(a) because the related parties used the QI to circumvent the Sec. 1031(f)(1) limitation.

In this Ruling, two individual taxpayers, who were related persons within the meaning ofSec. 267(b), I.R.C., held separate parcels of investment real property with the same fair marketvalue. Taxpayer #1 owned appreciated real property with a low basis. Taxpayer #2’s basis inhis property equaled its fair market value. Taxpayer #3, an unrelated taxpayer, sought topurchase the property owned by Taxpayer #1. Seeking to defer the immediate recognition ofgain on the sale of his property, Taxpayer #1 attempted to use a QI to structure a like kindexchange. Pursuant to an agreement, Taxpayer #1 transferred his property to the QI, who thensold the property to Taxpayer #3 for fair market value. Following this sale, the QI used the salesproceeds from the sale of Taxpayer #1’s property to acquire Taxpayer #2’s property. The QIthen transferred this property to Taxpayer #1.

Although taxpayers may use a QI to facilitate a like kind exchange, a taxpayerexchanging like kind property with a related person cannot use the nonrecognition provisions ofSec. 1031, I.R.C. if, within two years of the date of the last transfer, either the related persondisposes of the relinquished property or the taxpayer disposes of the replacement property. Thislimitation is intended to deny nonrecognition treatment for transactions in which related partiesmake like kind exchanges of high basis property for low basis property in anticipation of the saleof the low basis property. Moreover, nonrecognition is not available for a transaction or series oftransactions designed to avoid this limitation. In this scenario, because Taxpayer #1 employed aQI to circumvent this limitation, the nonrecognition provisions of Sec. 1031, I.R.C. do not applyto the exchange between Taxpayer #1 and the QI. Thus, Taxpayer #1 must recognize gain onthis exchange.

3. Several weeks after releasing Rev. Rul. 2002-83, the Service released Priv.Ltr. Rul. 200251008 (December 20, 2002). In this ruling, the Service held that an S corporationwill not recognize gain or loss in a like kind exchange of real property using the qualifiedexchange accommodation arrangement (“QEAA”) with an exchange accommodation titleholder(“EAT”). This transaction is sometimes referred to as a “parking” transaction. Rev. Proc. 2000-37, 2000-2 C.B. 308, set forth a safe harbor for acquiring replacement property through this typeof transaction. Even though the proposed parking transaction involved related parties, theService noted that Sec. 1031(f)(1) is not a concern in this case because the taxpayer and therelated parties continue to remain invested in the exchange properties and they are not cashingout their respective interests.

4. In 2005, the Tax Court decided the first case interpreting Sec. 1031(f)I.R.C. The Tax’s Court decision was affirmed by the Ninth Circuit on September 8, 2009. OnFebruary 22, 2010, the Supreme Court declined to review the Ninth Circuit’s decision. SeeTeruya Brothers Ltd. v. Comm’r, 124 T.C. 45 (2005), aff’d 580 F.3d 1038 (9th Cir. 2009), cert.denied Feb. 22, 2010. In 1995, Teruya Brothers Ltd. (“Teruya”) engaged in separate exchangesof two of its properties (“Property 1” and “Property 2”), as follows: Teruya entered into“exchange agreements” with a QI, whereby the QI agreed to complete the exchange of Property

-35-

1 and Property 2 for like kind replacement properties. Pursuant to its agreement with the QI,Teruya transferred its interests in Property 1 and Property 2 to the QI, and the QI then sold themto unrelated third parties. The QI applied the proceeds from the sale of Property 1 and Property2, as well as additional cash from Teruya, to purchase like kind replacement properties forTeruya from its subsidiary, Times Super Market Ltd. (“Times”). Teruya owned 62.5 percent ofthe Times common shares, which meant Times was a related person within the meaning of Sec.1031(f)(3), I.R.C.

The Court held that the transactions were structured to avoid the purpose of Sec. 1031(f),I.R.C., governing like kind exchanges between related parties. The transactions were theeconomic equivalent of direct exchanges of the properties between Teruya and Times, followedby Times’ sales of the properties to unrelated third parties. The interposition of a qualifiedintermediary in these transactions did not change the result. Consequently, the Courtdisqualified the exchanges from like kind exchange treatment under Sec. 1031(f)(4), I.R.C.

5. Recently, the Tax Court had another opportunity to interpret Sec. 1031(f),I.R.C. and reiterated the issues that may arise from acquiring replacement property formerlyowned by a related party. The Tax Court’s decision was affirmed by the Eleventh Circuit. InOcmulgee Fields v. Comm’r, 106 AFTR 2d 2010-5820 (11th Cir. 2010), aff’d 132 T.C. 6 (2009),the taxpayer exchanged appreciated property (“Wesleyan Station”) with a QI for replacementproperty (the “Barnes and Noble Corner”), formerly owned by a related party (“Treaty Fields”).Between the two legs of the exchange, the QI sold Wesleyan Station to an unrelated third partyand used the proceeds to acquire the replacement property from Treaty Fields. Because of thestep-up in basis in the Barnes and Noble Corner resulting from the exchange, Treaty Fieldsrealized a gain of approximately $1.8 million less than if the exchange has been forgone and ithad sold Wesleyan Station itself. Relying on the decision in Teruya Brothers Ltd. v. Comm’r,124 T.C. 45 (2005), the Tax Court stated that the transaction was economically equivalent to adirect exchange of properties between the taxpayer and the related person, followed by therelated person’s sale of the property and that the interposition of a qualified intermediary in thetransaction did not obscure the end result. As a result, the transaction was taxable pursuant toSec. 1031(f), I.R.C. .

The taxpayer appealed the Tax Court decision to the Eleventh Circuit and arguedthat the Tax Court’s factual findings that the taxpayer engaged in a series of transactionsstructured to circumvent Sec. 1031(f), I.R.C. were erroneous. Relying on the fact that thetransaction was structured with unnecessary complexity, allowed the parties to cash in on theirlow-basis property but pay tax as if they cashed in on their high-basis property, createdsignificant tax savings, and shifted nearly the entire burden of taxation to the party with thelowest tax rate, the Eleventh Circuit did not find the Tax Court’s decision to be clearly erroneousand thus affirmed its decision.

6. On January 28, 2010, the Service provided additional guidance regardingSec. 1031(f), I.R.C.. In Chief Counsel Advice 201013038 (January 28, 2010), the Serviceaddressed the situation where, under a master exchange agreement, two taxpayers (one thatleased equipment to unrelated parties and one that sold equipment at retail) used a qualifiedintermediary to exchange old equipment for new equipment. Although the dealer and taxpayer

-36-

were separate entities, they were related under Sec. 267(b), I.R.C.. Relying on Sec. 1031(f),I.R.C., which limits nonrecognition treatment for property exchanges between related parties, theAdvice concludes that the exchange fails to constitute a qualified like-kind exchange. In otherwords, the interposition of the qualified intermediary did not cause Sec. 1031(f), I.R.C. to beinapplicable. This reasoning is in alignment with the standards set forth in Rev. Rul. 2002-83,2002-2 C.B. 927, and Teruya Brothers Ltd. v. Comm’r, 124 T.C. 45 (2005), aff’d 580 F.3d 1038(9th Cir. 2009), cert. denied Feb. 22, 2010.

7. See Tech. Adv. Mem. 200126007 (March 22, 2001), in which the taxpayerowned investments in real property and operated several different businesses. The members oftwo families owned the stock of the taxpayer. The taxpayer and the shareholders of the taxpayerowned the stock in another corporation. The taxpayer and the other corporation were relatedparties within the meaning of Sec. 267(b), I.R.C. and for purposes of Sec. 1031(f)(3), I.R.C. Therelated party operated a retail business through various stores.

The taxpayer decided to dispose of its fee simple interest in a high-rise, residential rentalproperty (Property 1). On September 6, 1994, the taxpayer executed a letter of intent with therelated party corporation for the acquisition of two properties, Property 2 and Property 3, in thefirst of two separate like kind exchange transactions. The related party had purchased a parcel ofland for development in 1992. The related party subdivided the parcel into a large parcel(Property 2) and two small parcels (Property 5). The small parcels on Property 5 were leased forcommercial use. The related party obtained financing to develop a shopping center on Property2. The owner of Property 2 had the right to restrict the operation of a particular retail businessconducted on an adjoining property. The retail business competed with the related party’sshopping center and store located on Property 2. The taxpayer had an economic interest inacquiring Property 2 to control the level of competition for the related party’s store. Property 3was located adjacent to another property on which the related party’s store was located. Property2 and Property 3 shared a parking lot.

The taxpayer signed a contract to sell Property 1 to a purchaser with the closingscheduled to take place concurrently with the closing of the exchange transaction between March1, 1995 and July 31, 1995. On August 2, 1995 following the renegotiation of the purchase price,the taxpayer assigned the contract for the sale of Property 1 to an intermediary. On August 22,1995, the taxpayer guaranteed payment of part of the purchaser’s financing. The closing of thesale of Property 1 occurred on August 24, 1995, the same day as the closing of the sale ofProperty 2 and Property 3 with the intermediary.

The taxpayer also owned a fee simple interest in a parcel of land (Property 4) with acondominium constructed on the land. The taxpayer’s fee simple interest was subject to a long-term ground lease and a sublease with the Condominium Association. The taxpayer agreed tothe sale of the fee simple interest to the lessee under the long-term ground lease. The sale ofProperty 4 was conditioned on a like kind exchange cooperation provision. The taxpayer had alow basis in Property 4 and wanted to avoid the recognition of gain through the use of a like kindexchange. The Condominium Association was eventually substituted as the purchaser ofProperty 4. The sale of Property 4 finally closed on September 1, 1995 when the taxpayer

-37-

applied the proceeds to purchase Property 5 from the related party in a like kind exchangetransaction.

Section 1031(f)(1), I.R.C. disallows nonrecognition treatment where a taxpayer and arelated party enter into a like kind exchange transaction and then one of the parties disposes ofeither the relinquished property or the replacement property within two years of the exchange.Section 1031(f)(4), I.R.C. provides that Sec. 1031, I.R.C. does not apply to any exchange whichis part of a transaction or a series of transactions structured to avoid the purposes of Sec. 1031(f),I.R.C. The Service determined that the taxpayer’s multi-party exchanges facilitated the shiftingof the taxpayer’s low basis in its relinquished properties (Properties 1 and 4) to the replacementproperties (Properties 2, 3 and 5) owned by the related party prior to the exchanges. The Servicedetermined that the taxpayer and the related party had essentially cashed out certain investmentsin the real properties because the amounts realized from the sale of the taxpayer’s relinquishedproperties were applied to reduce the related party’s bank debt. Consequently, the Serviceconcluded that the taxpayer entered into both exchange transactions with a tax avoidance motive,so that neither of the exchange transactions qualified for nonrecognition treatment under Sec.1031, I.R.C.

The Service rejected the taxpayer’s various arguments, including that (1) the taxpayerand the related party were not the types of parties to which Sec. 1031(f)(4), I.R.C. was intendedto apply, and (2) the taxpayer’s exchanges were the result of permissible tax planning rather thana tax avoidance motive. The taxpayer also argued, unsuccessfully, that the multi-partyexchanges were not subject to Sec. 1031(f), I.R.C. which should apply to a direct or indirectrelated party exchange rather than related party sales of replacement property in transactionswith an intermediary. See also F.S.A. 199931002 (April 12, 1999), stating that Sec. 1031(f)(1),I.R.C. governs to the extent that an adjustment also could be made under the authority of Sec.1031(f)(4), I.R.C.

V. SIMULTANEOUS EXCHANGES

A. Description -- The seller/transferor and the buyer/transferee exchange title to likekind properties simultaneously. The seller/transferor transfers the relinquished property andreceives the replacement property in an integrated simultaneous transaction with thebuyer/transferee. The buyer/transferee acquires the relinquished property and transfers thereplacement property in an exchange transaction that occurs simultaneously.

B. Difficulties of Simultaneous Exchange -- The most typical difficulty inaccomplishing a simultaneous like kind exchange is the need to find two parties, each of whomdesires to exchange a property for one currently owned by the other. However, a simultaneousexchange may be accomplished successfully where the transferee is willing to wait to acquire thetransferor’s property until the transferor has designated like kind property and the transferor iswilling to designate such like kind property within a time frame acceptable to the transferee.

-38-

C. Use of an Intermediary -- In the case of simultaneous transfers of like kindproperties involving a QI, the QI is not considered the agent of the taxpayer for purposes of Sec.1031(a), I.R.C. Reg. §1.1031(b)-2(a).

D. Like Kind Transaction Agreement -- The transferor and transferee enter into astandard purchase and sale agreement (“Sales Agreement”). It is favorable, but not absolutelyrequired, that the Sales Agreement should include provisions whereby both parties covenant tocooperate so that the transferor may effectuate a like kind exchange. Note the effect of thefollowing provision:

Further Assurances. Buyer hereby covenants and agrees to use itsreasonable efforts and diligence to assist and cooperate with Seller inorder to effectuate a like kind exchange under Section 1031 of the InternalRevenue Code of 1986, as amended (“Section 1031”), including, withoutlimitation, executing and delivering any and all documents reasonablyrequired in accordance with the agreements of the parties set forth in thisAgreement; provided, however, that Buyer shall not incur any additionalcosts, expenses, liabilities, obligations or other financial risk with respectthereto.

It is important to note that Sec. 1031, I.R.C. provisions can be incorporated by referenceand added, by amendment if necessary, at any time prior to the actual closing in order to providefor the like kind exchange.

E. Illustrations

1. See Priv. Ltr. Rul. 199926045 (April 2, 1999), where the taxpayer and herdeceased husband owned substantial acreage in old-growth and young timberlands. A holdingcompany owned by a state held an option to acquire an undivided one-half interest in 39,000acres of the timberland owned by the taxpayer. The taxpayer was deemed to own more than 50percent in the holding company through attribution under Secs. 267(b) and 1031(f)(3), I.R.C.The holding company desired to exercise its option to acquire an interest in the old-growthtimber for development purposes. The taxpayer transferred her undivided one-half interest in aportion of various parcels of the old-growth timber in exchange for a 100 percent interest in oneor more parcels. The taxpayer’s transaction involved an exchange of undivided interests indifferent properties resulting in the taxpayer’s acquisition of an entire interest in a single propertyor a larger undivided interest in such properties. Consequently, the Service ruled that thetaxpayer’s transaction qualified as a like kind exchange and the planned cutting of timber withintwo years of such exchange would not trigger the recognition of gain or loss under the relatedparty rule of Sec. 1031(f)(1), I.R.C. See also Rev. Rul. 79-44, 1979-1 C.B. 265 (partitioning oftwo jointly owned parcels into two individually owned parcels); Rev. Rul. 73-476, 1973-2 C.B.300 (exchanges by three proportionate owners of three parcels of real estate for separately held100 percent interests in the same properties); and Rev. Rul. 72-515, 1972-2 C.B. 466(timberlands of differing quality and quantity exchanged).

-39-

2. See also Priv. Ltr. Rul. 199945046 (August 12, 1999), in which thetaxpayer was the son of the decedent and the decedent’s husband. The decedent and thedecedent’s husband each owned an undivided one-half interest as tenants in common in propertyused for ranching operations. The decedent’s husband held his undivided one-half interest in theranch property via a revocable trust, of which the decedent’s husband was the grantor, trusteeand beneficiary. The decedent also conveyed her undivided one-half interest in the property to arevocable trust, which became irrevocable on the death of the decedent. The undivided one-halfinterest in the property owned by the decedent’s trust was included in the gross estate of thedecedent and was transferred to the taxpayer, who is the son of the decedent. The executor of thedecedent’s estate elected to have the undivided one-half interest valued in the decedent’s estateaccording to the special use valuation provision of Sec. 2032A, I.R.C. The value of the qualifiedreal property, including ranches, in the estate is the value based on qualified use rather than fairmarket value.

The taxpayer proposed to enter into a simultaneous exchange of his undivided one-halfinterest in the ranch property for a 100 percent fee simple interest in one half of the property.The taxpayer and the revocable trust of the decedent’s husband would each convey theirundivided one-half interest in the ranch property in exchange for a 100 percent interest in one-half of the property. The transfer of ownership was accomplished by the exchange of quitclaimdeeds, and no cash or other property was transferred in the transaction.

Section 2032A(c)(1), I.R.C. provides that additional estate tax is imposed if, within 10years after a decedent’s death, a qualified heir disposes of an interest in qualified real property(other than by disposition to a family member) or the qualified heir ceases to use the qualifiedreal property for the qualified use. Section 2032A(i)(1)(A), I.R.C. provides that, if an interest inreal property is exchanged solely for an interest in qualified exchange property in a transactionwhich qualifies under Sec. 1031, I.R.C., no additional estate tax is imposed by Sec. 2032A(c),I.R.C. The Service considered whether the exchange of the taxpayer’s interest was a dispositionwithin 10 years of the decedent’s death for purposes of imposing additional estate tax under Sec.2032A(c)(1), I.R.C. The Service also addressed the issue of whether the exchange qualifiedunder Sec. 1031, I.R.C. so that additional estate tax would not be imposed by Sec. 2032A(c),I.R.C.

The Service treated the decedent’s husband as the owner of the property held by hisrevocable trust since he was the grantor, trustee and beneficiary. Consequently, the taxpayer wasconsidered to have transferred his undivided one-half interest in the property to the decedent’shusband, i.e., his father. The Service concluded that no additional estate tax would be imposedunder Sec. 2032A(c)(1), I.R.C. following the taxpayer’s exchange occurring within 10 years ofthe decedent’s death because the taxpayer transferred his interest to a family member.

The Service also concluded that the taxpayer’s transfer of his undivided one-half interestin the ranch property in exchange for a 100 percent fee simple interest in one-half of the propertyqualified as a like kind exchange under Sec. 1031, I.R.C. The decision was based on the analysisprovided in Rev. Rul. 73-476, 1973-2 C.B. 300 (nonrecognition treatment accorded to threetaxpayers who exchanged undivided one third interests in three parcels of land for a 100 percentownership interest in one parcel of land) and Rev. Rul. 79-44, 1979-1 C.B. 265 (nonrecognition

-40-

treatment accorded to two taxpayers who exchanged undivided one-half interests in two parcelsof land for a 100 percent interest in one parcel of land).

VI. DEFERRED LIKE KIND EXCHANGES

A. Overview -- Reg. §1.1031(k)-1(a) currently provides that a deferred exchange isan exchange in which, pursuant to an agreement, the taxpayer transfers property held forproductive use in a trade or business or for investment (the “relinquished property”) andsubsequently receives property to be held either for productive use in a trade or business or forinvestment (the “replacement property”).

1. Because of the timing difficulties in finding suitable replacement property,the deferred like kind exchange has become very popular. It first was widely publicized as aresult of Starker v. United States, 602 F.2d 1341 (CA9 1979), rev’g 432 F.Supp. 864 (D. Or.1977), where the Court held that an exchange qualified for nonrecognition treatment even thoughunder the agreement, the transferor (1) could designate the property to be exchanged for up tofive years after the transaction, and (2) could receive cash instead of replacement property.

2. As part of the Tax Reform Act of 1984, Congress adopted, but limited, theapplication of Starker by adding Sec. 1031(a)(3), I.R.C. to the Code. Sec. 1031(a)(3), I.R.C.provides that any property received by a taxpayer in a deferred exchange is treated as propertywhich is not like kind property if --

a. Such property is not identified as property to be received in theexchange on or before the day which is 45 days after the date on which the taxpayer transfers theproperty relinquished in the exchange, or

b. Such property is received after the earlier of --

(1) the day which is 180 days after the date on which thetaxpayer transfers the property relinquished in the exchange, or

(2) the due date (including extensions) of the taxpayer’s taxreturn for the taxable year in which the transfer of the relinquished property occurs.

3. Sec. 1031(a)(3), I.R.C., was enacted due to concern by Congress that,without the statutory restrictions, the application of Sec. 1031, I.R.C. to deferred exchangeswould give rise to unintended results and administrative problems. Particularly from theperspective of the Treasury, the greater the taxpayer’s discretion to vary the particular propertyto be received in exchange for the relinquished property and to vary the date on which suchreplacement property (or money) is to be received, the more the transaction is appropriatelytreated as a sale and not as a like kind exchange.

4. As a practical matter, any 180-day exchange period which runs beyondApril 15 of the subsequent year will require the individual taxpayer to file an extension of its

-41-

income tax return for the prior year. The extension essentially allows the taxpayer to takeadvantage of the exchange period in order to close out the deferred exchange after April 15 ofthe subsequent year. See Christensen v. Comm’r, 98-1 USTC ¶50,352 (CA9 1998), aff’g 71TCM 3137 (1996), where the taxpayer argued unsuccessfully that the permissible period for thetax-free exchange should be extended by the automatic four-month extension of time to file. Thecourt did not concur because the extension is not actually automatic since the taxpayer mustapply for it using Form 7004.

5. Additionally, there is no good faith exception for the failure to meet thetiming requirements. In Knight v. Comm’r, 75 TCM 1992 (1998), the Court disallowed deferredexchange treatment because the taxpayers’ receipt of property fell outside the statutory 180-daywindow, despite the good faith efforts of taxpayers to comply. The fact that the seller cancelledthe sale one day before the 180-day period expired did not constitute grounds for exemptionfrom the Sec. 1031(a)(3), I.R.C. time period, even though the circumstances were beyond thetaxpayers’ control. The Court held that it lacked jurisdiction to provide taxpayers with theequitable relief they sought. An exchange transaction will not qualify for nonrecognitiontreatment if the taxpayer fails to comply with the 45-day identification requirements. SeeDobrich v. Comm’r, 74 TCM 985 (1997) (no deferral where taxpayer failed to identify propertywithin 45 days).

6. In order to constitute a deferred exchange, the transaction must be anexchange (that is, a reciprocal transfer of property for property, as distinguished from a transferof property for money). Reg. §1.1031(k)-1(a). In C. Bean Lumber Transport, Inc. v. UnitedStates, 99-1 USTC ¶50,474 (W.D. Ark. 1999), the taxpayer negotiated the purchase of newtrucks and trade-in of used trucks at the same time, but each transaction was documentedseparately and the used trucks were paid for by the dealership by check, not as a credit againstthe purchase of new trucks. The court held that the transactions did not qualify as like kindexchanges because they were not reciprocal and mutually dependent, distinguishing RedwingCarriers, Inc. v. Tomlinson, 399 F.2d 652 (CA5 1968).

7. If the taxpayer actually or constructively receives money or propertywhich does not meet the requirements of Sec. 1031(a), I.R.C. (that is, “other property” or actualor constructive receipt of cash) in the full amount of the consideration for the relinquishedproperty, the transaction will constitute a sale, and not a deferred exchange, even though thetaxpayer may ultimately receive like kind replacement property. Reg. §1.1031(k)-1(a). In BigHong Ng v. Comm’r, 73 TCM 2900 (1997), for example, the taxpayer initially complied with allof the requirements in order to qualify under Sec. 1031, I.R.C., engaging a QI to sell a propertyowned by the taxpayer personally, then purchasing a property from the taxpayer’s wholly ownedcorporation. After the exchange, however, the taxpayer withdrew the funds from the corporateaccount and used them to pay personal expenses. The court determined that the transaction wasa “sham”, and, therefore, disallowed the deferral of gain.

8. Forward Deferred Like Kind Exchange -- In Priv. Ltr. Rul. 200111025(December 8, 2000), the taxpayer owned a park and was in the business of real estate investmentand leasing operations. The taxpayer entered into an option agreement with a tax-exemptconservation organization that desired to acquire the park. The option agreement contained a

-42-

tax-deferred exchange cooperation provision, which reserved the right to the taxpayer toexchange the park in a Sec. 1031, I.R.C. nonrecognition transaction. The taxpayer’s transfer ofthe park as the relinquished property in exchange for replacement property acquired from anaccommodation party qualified for nonrecognition treatment under Sec. 1031, I.R.C.

a. Relinquished Property -- The conservation organization desired toacquire the taxpayer’s park for public recreational purposes. The taxpayer and the conservationorganization entered into a bargain sale option agreement for the sale of the park. The agreementprovided an exclusive and irrevocable contingent option for the conservation organization toacquire the park. The option was contingent upon the passage of certain state bond legislationwhich actually occurred.

b. Replacement Property -- The business operations of theaccommodation party involved the acquisition, ownership, leasing, financing and disposition ofreal property. The accommodation party acquired the taxpayer’s replacement property andfinanced the acquisition. The financing consisted of a loan obtained by the accommodation partyfrom a bank and the concomitant guaranty of the taxpayer. Subsequently, the taxpayer leased thereplacement property from the accommodation party under an agreement with the standardprovisions of a triple net lease.

c. Forward Deferred Exchange -- The Service applied a three-parttest to determine if the taxpayer was entitled to nonrecognition treatment under Sec. 1031, I.R.C.The exchange of the park qualified as a forward deferred like kind exchange based on thefollowing factors:

(1) The taxpayer had the requisite intent to enter into a forwarddeferred like kind exchange according to Sec. 1031(a)(3), I.R.C.;

(2) The taxpayer’s transaction was part of an integrated plan toexchange the park as the relinquished property for the replacement property; and

(3) The accommodation party was not considered as thetaxpayer’s agent for the purpose of holding the replacement property.

9. See F.S.A. 200048021 (August 29, 2000), in which the taxpayer sold fourproperties to his children in a transaction intended to qualify as a like kind exchange. Thechildren financed the acquisition of the taxpayer’s relinquished property by executing a note withan escrow agent. Subsequently, the taxpayer acquired the replacement property. The taxpayerswere not entitled to nonrecognition treatment under Sec. 1031, I.R.C. because the transaction didnot meet the following requirements:

a. The escrow agent did not meet the definition of a QI under theregulations;

b. The taxpayer failed unambiguously to identify the replacementproperty; and

-43-

c. The taxpayer constructively received the proceeds from thetransfer of the relinquished property prior to receiving the replacement property.

B. Actual and Constructive Receipt of Money or Other Property -- The Safe Harbors

1. The issue of receipt of cash or a cash equivalent arises in the context of adeferred like kind exchange because of the transferor’s need for security after the transfer of theexchange property to the transferee, but before the receipt of the replacement property by thetransferor. Such security arrangements may be challenged on the grounds that they constitute theactual or constructive receipt of cash or a cash equivalent. Generally, if a taxpayer actually orconstructively receives money or other property from the transfer of relinquished property beforethe taxpayer receives like kind replacement property, then the transaction constitutes a sale ratherthan a deferred exchange. Reg. §1.1031(k)-1(f)(1).

a. The taxpayer is in actual receipt of money or property at the timethe taxpayer actually receives such money or property or receives the economic benefit thereof.Reg. §1.1031(k)-1(f)(2).

b. The taxpayer is in constructive receipt of money or property at thetime such money or property is credited to the taxpayer’s account, or set apart for the taxpayer,or otherwise made available so that the taxpayer may draw upon it, either immediately or aftergiving appropriate notice. Reg. §1.1031(k)-1(f)(2).

c. Where the taxpayer’s control of the receipt of money or property issubject to substantial limitations or restrictions, constructive receipt occurs at the time suchlimitations or restrictions lapse, expire or are waived. Reg. §1.1031(k)-1(f)(2).

d. The general rules governing actual or constructive receipt by thetaxpayer (or his or her agent or representative) thus apply, without regard to the taxpayer’smethod of accounting.

2. There are four safe harbors which, if used correctly by the taxpayer, willnot create an actual or constructive receipt of money or other property for purposes of Sec.1031(a)(3), I.R.C. Nonetheless, the safe harbors apply only until the taxpayer has the ability orunrestricted right to receive money or other property. Reg. §1.1031(k)-1(g)(1).

3. Safe Harbor No. 1 (Security or Guarantee Arrangements) --

a. There will not be actual or constructive receipt where theobligation of the taxpayer’s transferee (that is, the person to whom the taxpayer transfers therelinquished property) to transfer the replacement property to the taxpayer is or may be securedor guaranteed by one or more of the following:

(1) A mortgage, deed of trust or other security interest inproperty (other than cash or a cash equivalent);

-44-

(2) A standby letter of credit which meets the requirements ofReg. §15A.453-1(b)(3)(iii) and which does not allow the taxpayer to draw on it except on adefault of the taxpayer’s transferee’s obligation to transfer like kind property to the taxpayer; or

(3) A guarantee of a third party. Reg. §1.1031(k)-1(g)(2).

b. As to the standby letter of credit, see Reg. §15A.453-1(b)(5) Exs.(7) and (8).

4. Safe Harbor No. 2 (Qualified Escrow Accounts and Qualified Trusts) --

a. The obligation of the taxpayer’s transferee to transfer thereplacement property to the taxpayer may be secured by cash or a cash equivalent if the cash orcash equivalent is held in a qualified escrow account or in a qualified trust. Reg. §1.1031(k)-1(g)(3).

b. As set forth in Reg. §1.1031(k)-1(g)(3), a qualified escrow accountor trust is an escrow account or trust where --

(1) The escrow holder or the trustee is not the taxpayer or adisqualified person (as defined in Reg. §1.1031(k)-1(k)) [see Part VI. C. below, for the definitionof a disqualified person]; and

(2) The taxpayer’s right to receive, pledge, borrow orotherwise obtain the benefits of the cash or cash equivalent held in the escrow account or by thetrustee are limited (the “(g)(6) limitations”) so that the taxpayer does not have the right to receivethe money or other property in the qualified escrow account or qualified trust until (as set forth inReg. §1.1031(k)-1(g)(6)) --

(a) If the taxpayer has not identified replacementproperty before the end of the identification period, after the end of the identification period; or

(b) After the taxpayer has received all of the identifiedreplacement property to which the taxpayer is entitled; or

(c) If the taxpayer identifies replacement property, afterthe end of the identification period and the occurrence of a material and substantial contingencythat

(i) relates to the deferred exchange,

(ii) is provided for in writing, and

(iii) is beyond the control of the taxpayer andany disqualified person; or

-45-

(d) Otherwise, after the end of the exchange period.

c. On July 9, 2008, the Service issued Final Regulations under Secs.468B and 7872, I.R.C. regarding the taxation of income earned on escrow accounts used duringdeferred like kind exchanges, effective for transfers of relinquished property made by taxpayerson or after October 8, 2008. In general, the Final Regulations treat the funds (property or cash)held in an escrow account, trust or fund in a like kind exchange as a demand loan from thetaxpayer to the exchange facilitator (QI or other party that holds the funds) (an “exchangefacilitator loan”). All items of income, deduction and credit (including capital gains and losses)attributable to the funds are taken into account by the exchange facilitator. Reg. §1.468B-6(c)(1).

(1) There are exceptions to the exchange funds being treated asa loan.

(a) If the escrow agreement, trust agreement orexchange agreement specifically provides that all the earnings attributable to exchange funds arepayable to the taxpayer, the exchange funds are not treated as an exchange facilitator loan. Reg.§1.468B-6(c)(2).

(b) If an exchange facilitator holds all of the taxpayer’sexchange funds in a bank or other depository institution in a separately identified account or asubaccount, the exchange funds will not be treated as an exchange facilitator loan. Reg.§1.468B-6(c)(2)(ii).

(c) If an exchange facilitator commingles (forinvestment or otherwise) the taxpayer’s exchange funds with other funds or assets, but all of theearnings are allocated on a pro rata basis, the exchange funds will not be treated as an exchangefacilitator loan. Reg. §1.468B-6(c)(2).

(2) If the exchange funds are not treated as an exchangefacilitator loan, the taxpayer must take into account all items of income, deduction and credit(including capital gains and losses) attributable to the exchange funds. Reg. §1.468B-6(c)(2)(iii).

(3) If exchange funds are treated as loaned by the taxpayer toan exchange facilitator, interest generally is imputed under Sec. 7872, I.R.C. unless the exchangefacilitator pays sufficient interest using a special AFR. This special AFR is the lower of theshort-term AFR in effect under Sec 1274(d)(1), I.R.C. (as of the day on which the loan is made),compounded semiannually, or the 91-day rate. The 91-day rate is equal to the investment rate ona 13-week T-bill.

(4) If interest is imputed under Sec. 7872, I.R.C. income isdeemed transferred to the exchange facilitator as compensation and retransferred to the taxpayeras interest. The exchange facilitator has income from the imputed compensation and anoffsetting deduction for the interest deemed paid to the taxpayer. Reg.§ 1.7872-16(c) andPreamble to T.D. 9413.

-46-

(5) The Final Regulations provide a generous exemption fromimputing interest under Sec. 7872, I.R.C. for exchange transactions in which the amount ofexchange funds treated as loaned does not exceed $2 million and the funds are held for 6 monthsor less. This exemption amount may be increased in future published guidance. Regs. §§1.7872-5(b)(16) and 1.7872-16(f). This exception will help small non-bank facilitators stay competitivewith banks, which do not generally retain some earnings to augment the fee. Because most ofthe exchange transactions with small non-bank facilitators will fall under the $2 millionexception, the legislation should allow such facilitators to avoid paying earnings to clients and,thus, raising their basic fee to offset it.

d. See Priv. Ltr. Rul. 200027028 (July 7, 2000), holding that anamended exchange agreement did not meet the requirements of Reg. §1.1031(k)-1(g)(6)(iii).The taxpayer entered into a like kind exchange transaction with the use of a QI. The agreementprovided that the taxpayer was entitled to receive the proceeds from the exchange before the endof the exchange period only if certain events occurred. The QI amended the agreement toprovide that the taxpayer could receive the proceeds before the end of the exchange period to theextent that a binding agreement for the replacement properties was not concluded. See, as adistinct contrast to the safe harbor, Greene v. Comm’r, 62 TCM 512 (1991). See also, as to thetaxpayer’s failure to follow the appropriate guidelines, Klein v. Comm’r, 66 TCM 1115 (1993),and Hillyer v. Comm’r, 71 TCM 2945 (1996).

e. See Priv. Ltr. Rul. 9448010 (December 2, 1994), where the escrowwas non-interest bearing, but the taxpayer instead received fee waivers from the bank where theescrow was located. This was held not to violate the safe harbor because such benefits were notavailable until the end of the exchange period.

f. See also Tech. Adv. Mem. 199907029 (February 19, 1999),wherein a partnership with four partners owned real property including an apartment buildingthat was destroyed in a natural disaster. Three of the partners from the original partnershipcontinued to operate their business as a continuation of the first partnership. The secondpartnership transferred the real property remaining after the natural disaster in a like kindexchange transaction. The partners in the second partnership used the insurance proceeds fromthe destruction of the apartment building to purchase replacement property within the scope ofSec. 1033, I.R.C. The Service determined that the exchange qualified for the deferral of gain asan involuntary conversion but did not meet the requirements of Reg. §1.1031(k)-1(g)(6)(i). Thetransaction did not qualify for the safe harbor because one of the partners received proceeds fromthe disposition of the relinquished property prior to the expiration of the exchange period.

g. The rights of the taxpayer under state law to terminate or dismissthe qualified escrow holder or trustee of a qualified trust are disregarded in considering whetherthe taxpayer has an immediate ability or unrestricted right to receive, pledge, borrow orotherwise obtain the benefits of the cash or cash equivalent held in the qualified escrow accountor qualified trust. Reg. §1.1031(k)-1(g)(3)(iv).

h. Detailed escrow provisions may be placed in the Sales Agreementor the parties may elect to enter into a separate Escrow Agreement.

-47-

5. Safe Harbor No. 3 (Interest and Growth Factors) --

a. If the (g)(6) limitations likewise apply to any interest or growthfactor, then such interest or growth factor will not cause the taxpayer to be in actual orconstructive receipt. Reg. §1.1031(k)-1(g)(5).

b. The taxpayer is treated as receiving interest or a growth factor ifthe amount of money or property the taxpayer is entitled to receive depends on the length of timeelapsed between the transfer of the relinquished property and the receipt of the replacementproperty. Reg. §1.1031(k)-1(h)(1).

c. The interest or growth factor will be treated as interest, regardlessof whether it is paid to the taxpayer in cash or in property (including like kind property), andmust be included in income according to the taxpayer’s method of accounting. Reg. §1.1031(k)-1(h)(2).

6. Safe Harbor No. 4 (Qualified Intermediaries) --

a. If the taxpayer’s transferee is a QI and if the (g)(6) limitationsapply, then it does not matter whether or not the taxpayer’s transferee is the taxpayer’s agent.Regs. §§1.1031(k)-1(g)(4)(i) and (ii).

b. A QI is a person who --

(1) Is not the taxpayer or a disqualified person [see Part VI. C.below, for the definition of a disqualified person]; and

(2) Acts to facilitate the deferred exchange by entering into awritten agreement with the taxpayer for the exchange of properties pursuant to which suchperson

(a) acquires the relinquished property from thetaxpayer,

(b) transfers the relinquished property (either on itsown behalf or as the agent of any party to the transaction),

(c) acquires the replacement property (either on its ownbehalf or as the agent of any party to the transaction), and

(d) transfers the replacement property (either on its ownbehalf or as the agent of any party to the transaction) to the taxpayer. Reg. §1.1031(k)-1(g)(4)(ii).

(3) The QI does not have to take legal title to either therelinquished property or the replacement property so long as the rights of a party to the

-48-

agreement are assigned to the intermediary and all the parties are notified in writing of theassignment on or before the date of the relevant transfer of property. Reg. §1.1013(k)-1(g)(4)(v).See Priv. Ltr. Rul. 200242009 (October 18, 2002) (each transfer by the taxpayer of arelinquished vehicle in the taxpayer’s leasing business followed by the receipt of an identifiedreplacement vehicle in accordance with the Exchange Agreement constituted separate like kindexchanges that qualified for nonrecognition treatment); and Tech. Adv. Mem. 200130001 (July27, 2001) (a series of transactions did not meet the requirements of the QI safe harbor andtherefore did not qualify as like kind exchanges under Sec. 1031, I.R.C.). See also Rev. Rul. 90-34, 1990-1 C.B. 154. It is certainly in the best interests of an intermediary to avoid taking legaltitle to the property because of the possibility of environmental liability in the event the propertyis contaminated. Additionally, the Service has ruled that an intermediary’s disbursement offunds from an account for the purchase of nonreplacement property constitutes acceptable“routine financial trust services” which will not disqualify the intermediary from being a QI.Priv. Ltr. Rul. 9812013 (December 12, 1997).

c. Generally, at some time prior to the settlement of the transferor’sproperty (the “Settlement Date”), the transferor and the QI enter into an Exchange Agreement.As with the escrow provisions and the form Escrow Agreement, this document sets out inspecific detail, and with specific instructions to the respective parties, the procedures foraccomplishing the like kind exchange through a QI. It is recommended that the transferoraccomplish this step prior to entering into a Sales Agreement with the transferee. Ifaccomplished in advance, the QI can negotiate directly with the transferee and there is no needfor the assignment of the Sales Agreement.

d. Also prior to or at settlement on the transferor’s property, if the QIhas not dealt directly with the transferee, the transferor assigns the Sales Agreement to the QI.At settlement, however, the QI will instruct the transferor to convey its property directly to thetransferee in order to avoid duplicate recordation and transfer taxes as well as potential chain oftitle liability to the QI.

e. Finally, prior to 180 days after the Settlement Date, the QI or thetransferor enters into a purchase contract for the replacement property or properties. Thepreferred course of action is to have the QI enter into the contract. However, it is acceptable(although revenue agents examine such transactions more closely) to have the transferor contractand then assign the exchange contract to the QI through an Assignment of Purchase Agreement.As a general rule in this regard, however, it is important that the seller of the replacementproperty either (1) permit (in the exchange agreement or by written consent) an assignment ofthe exchange agreement to the transferee, or (2) agree in writing to cooperate with the transferorin order to effectuate a like kind exchange.

f. In addition, the QI should not enter into a purchase contract unlessspecified damages are the seller’s sole remedy, and the transferor has held the QI harmless fromthe same.

-49-

g. The QI may construct, or cause to be constructed, theimprovements on the replacement property prior to the transfer to the taxpayer. Priv. Ltr. Rul.9428007 (April 13, 1994).

h. Where a QI is used with respect to a portion of the propertyexchanged, and the taxpayer constructively receives cash for the sale of the remainder of theproperty, gain is deferred as to the portion that qualifies. See Tech. Adv. Mem. 199907029(February 19, 1999) (where partnership exchanged property and departing partner received shareof proceeds directly from intermediary, gain recognized to the extent of constructive receipt bypartnership).

i. The conversion of a QI from a qualified S corporation subsidiaryto a C corporation does not cause the entity to be treated as a new or different QI, so, withrespect to pending like kind exchanges, the QI retains its status as transferee of relinquishedproperty. See Priv. Ltr. Rul. 200908005 (November 18, 2008).

j. In 2010, the Service and Treasury became aware that there weremany taxpayers who initiated like-kind exchanges by transferring relinquished property to aqualified intermediary and thereafter were unable to complete these exchanges within theexchange period solely due to the failure of the qualified intermediary to acquire and transferreplacement property to the taxpayer. In many of these cases, the qualified intermediary enteredinto bankruptcy or receivership, thus preventing the taxpayer from obtaining immediate access tothe proceeds of the sale of the relinquished property. To assist taxpayers who in good faithsought to complete the exchange using the qualified intermediary, but were prevented fromdoing so because the qualified intermediary defaulted on the exchange agreement, the Serviceissued Rev. Proc. 2010-14, 2010-12 I.R.B. 456.

(1) Under Rev. Proc. 2010-14, if a qualified taxpayer fails tocomplete its like-kind exchange because the QI defaulted on its obligation to acquire and transferreplacement property (a “QI Default”) and such QI becomes subject to a bankruptcy orreceivership proceeding, the taxpayer does not need to recognize gain from the failed exchangeuntil the taxable year in which the taxpayer receives payment attributable to the relinquishedproperty. To avail itself of the benefits of this Revenue Procedure, the taxpayer must have:

(a) Relinquished the property to a qualifiedintermediary in accordance with Reg. §1.1031(k)-1(g)(4);

(b) Identified replacement property within theidentification period (unless the QI Default occurred during that period);

(c) Not been able to complete the like-kind exchangesolely because of the QI Default involving a qualified intermediary that became subject to abankruptcy proceeding under the United States Code or a receivership proceeding under Federalor state law; and

-50-

(d) Not been in actual or constructive receipt of theproceeds (disregarding any proceeds actually or constructively received by the qualifiedintermediary) from the disposition of the relinquished property or any property of the qualifiedintermediary prior to the time the qualified intermediary entered bankruptcy or receivership.

(2) Generally, this Revenue Procedure is effective fortaxpayers whose like-kind exchanges failed because of a QI default occurring on or after January1, 2009. However, a taxpayer who is within the scope of this Revenue Procedure may, subject tothe Sec. 6511, I.R.C. limitations on credit or refund, file an original or amended return to report adeferred like-kind exchange that failed due to a QI default in a tax year ending before January 1,2009, in accordance with this Revenue Procedure.

k. Note, however, that the use of a QI is merely a safe harbor. Anexchange that utilizes a non-qualified intermediary may also qualify for Sec. 1031, I.R.C.treatment. See F.S.A. 1999-485 (settlement “may be appropriate” for like kind exchangesutilizing a non-QI).

C. The Disqualified Person

1. A person is a disqualified person (under Reg. §1.1031(k)-1(k)(1)) if --

a. Such person and the taxpayer bear a relationship described in Sec.267(b), I.R.C. or 707(b), I.R.C., but substituting 10% for 50% each place it appears; or

b. Such person is the taxpayer’s agent at the time of the transaction,including persons performing services as the taxpayer’s employee, attorney, accountant,investment banker or broker; or

c. Such person and the taxpayer’s agent bear a relationship describedin Sec. 267(b), I.R.C. or 707(b), I.R.C., but substituting 10% for 50% each place it appears.

2. A person who has acted as the taxpayer’s employee, attorney, accountant,or real estate agent or broker, within the 2-year period ending on the date of the transfer of thefirst of the relinquished properties is treated as an agent of the taxpayer at the time of thetransaction. See Priv. Ltr. Rul. 200338001 (June 11, 2003) (concluding that an intermediaryLLC managed but not owned by a disqualified person is not a disqualified person). However,Reg. §1.1031(k) -1(k)(4) provides that a bank or bank affiliate that is a member of a bankingcontrolled group is not a disqualified person if --

a. The bank or bank affiliate is a member of a controlled group thatincludes a member which provides investment banking or brokerage services; and

b. The investment banking or brokerage services member hasprovided services to the taxpayer in a Sec. 1031, I.R.C., transaction within the two years beforethe relinquished property is transferred

-51-

3. In determining whether a person is the taxpayer’s agent, solely forpurposes of the disqualified person concept, the following are not taken into account:

a. The performance of services for the taxpayer with respect toexchanges of property intended to qualify under Sec. 1031, I.R.C.; and

b. The performance by a financial institution, title insurance companyor escrow company of routine financial, title insurance, escrow or trust services for the taxpayer.Reg. §1.1031(k)-1(k)(2).

(1) The Service has concluded that lending money to facilitatelike kind exchanges would not cause a privately held specialty finance company to bedisqualified under Reg. §1.1031(k)-1(k). The Service determined that (i) the finance companywas a financial institution that was providing routine services to its customers and (ii) the financecompany avoided the six “National Carbide factors”, an agency analysis set out in NationalCarbide Corp. v. Comm’r, 336 U.S. 422 (1949). Priv. Ltr. Rul. 200630005 (May 24, 2005).

(2) In Priv. Ltr. Ruls. 200803003 (October 17, 2007) and200803014 (November 9, 2007), the Service held that a taxpayer (bank) could use a bank, thatwas wholly owned by one of its wholly owned subsidiaries, as a QI, as long as the bank wasdefined in Sec. 581, I.R.C.

(3) In Priv. Ltr. Rul. 201030020 (April 29, 2010), the Serviceruled that a bank would not be considered a disqualified person under Reg. § 1.1031(k)-1(k) if itprovided services to its customers simultaneously as a qualified intermediary (under safe harborno. 4) and as a trustee of the customer’s qualified trust (under safe harbor no. 2).

D. Identification and Receipt Requirements

1. Generally, replacement property will not be treated as property which is ofa like kind to the relinquished property if --

a. The replacement property is not “identified” before the end of the“identification period”; or

b. The identified replacement property is not received before the endof the “exchange period”. Reg. §1.1031(k)-1(b)(1).

(1) In Priv. Ltr. Rul. 200211016 (March 15, 2002), the Serviceheld that Sec. 6503(b) does not authorize the Service to suspend the 180-day replacement period,even under circumstances where a state agency took possession and control of the QI, appointeda receiver and froze all of its assets, including the taxpayer’s proceeds from the sale of thereplacement property.

(2) More recently, however, in Rev. Proc. 2010-14, 2010-12I.R.B. 456, the Service ruled that, if a qualified taxpayer fails to complete a like-kind exchange

-52-

within the 180-day replacement period because the QI entered into bankruptcy or receivershipand thus defaulted on the exchange agreement, the taxpayer will not be required to recognizegain from the failed exchange until the taxable year in which the taxpayer actually receives apayment attributable to the relinquished property.

(3) In addition, for Federally declared disasters declared afterDecember 31, 2007 and occurring before January 1, 2010 and certain terroristic or militaryactions, Sec. 7508A, I.R.C. provides the Service with the ability to postpone deadlines (includingthe 180-day replacement period deadline) for up to one year.

(4) See also Notice 2001-68, 2001-2 C.B. 504 and Rev. Proc.2007-56, 2007-34 I.R.B. 388, which provide a 120-day postponement of the replacement perioddeadline for taxpayers affected by 9/11 and Federally declared disasters, respectively.

2. Definitions --

a. The “identification period” begins on the date the taxpayertransfers the relinquished property and ends at midnight 45 days thereafter. Reg. §1.1031(k)-1(b)(2)(i).

b. The “exchange period” begins on the date the taxpayer transfersthe relinquished property and ends at midnight on the earlier of 180 days thereafter or the duedate (including extensions) for the taxpayer’s income tax return for the taxable year in which thetransfer of the relinquished property occurs. Reg. §1.1031(k)-1(b)(2)(ii).

(1) In Priv. Ltr. Rul. 200211016 (March 15, 2002), thetaxpayer executed a real estate exchange agreement with an intermediary in a Sec. 1031, I.R.C.transaction. The taxpayer directed the closing agent to pay over the sale proceeds to theintermediary. A state agency took possession and control of the intermediary and appointed areceiver. All of the assets of the intermediary were frozen including the taxpayer’s saleproceeds. The taxpayer submitted a designation form to the receiver to designate replacementproperty and entered into a contract to purchase the property. The taxpayer was prevented frompurchasing the replacement property within the required 180-day exchange period because thesale proceeds continued to be frozen as part of the receivership against the intermediary. TheService concluded that Sec. 6503(b), I.R.C. does not authorize the Service to suspend the 180-day exchange period. Section 6503(b), I.R.C. generally provides that the period of limitation oncollection is suspended for the duration that the assets of the taxpayer are in the control orcustody of a state or federal court.

c. If, as part of the same deferred exchange, the taxpayer transfersmore than one relinquished property, and these properties are transferred on different dates, boththe identification period and the exchange period are determined by reference to the earliest dateon which any of such properties are transferred. Reg. §1.1031(k)-1(b)(2)(iii).

-53-

3. Identification of the Replacement Property --

a. Generally, any property in fact received by the taxpayer before theend of the identification period will in all events be treated as identified before the end of theidentification period. Reg. §1.1031(k)-1(c)(1).

b. Identification occurs only in one of two ways, as follows:

(1) Identification in a written agreement signed by all partiesthereto before the end of the identification period. Reg. §1.1031(k)-1(c)(2).

(2) Identification in a written document signed by the taxpayerand sent (by hand delivery, mail, telecopy or otherwise) before the end of the identificationperiod to either the person obligated to transfer the replacement property to the taxpayer or to aperson involved in the exchange other than the taxpayer or a disqualified person. Reg.§1.1031(k)-1(c)(2). Property which is being constructed must be identified with as much detailand specificity as practicable. Note that discussions regarding a given replacement propertywhich took place prior to the expiration of the identification period, supplemented by backdatedletters reflecting the identification of the replacement property, were held to be clearlyinsufficient to comply with the identification period rules of Reg. §1.1031(k)-1(b)(2)(i). Dobrichv. Comm’r, 74 TCM 985 (1997).

c. Replacement property is identified only if it is unambiguouslydescribed in the written document or agreement. Reg. §1.1031(k)-1(c)(3).

(1) Real property is so described if described by a legaldescription, street address or distinguishable name.

(2) Personal property is so described if described by a specificdescription of the particular type of property.

d. The taxpayer may identify more than one property as replacementproperty subject to applicable limitations set forth in the Regulations.

(1) Regardless of the number of relinquished propertiestransferred by the taxpayer as part of the same deferred exchange, the maximum number ofreplacement properties that may be identified is --

(a) Three properties without regard to their fair marketvalues (the “3-property rule”); or

(b) Any number of properties so long as their aggregatefair market value at the end of the identification period does not exceed 200% of the aggregatefair market value of all the relinquished properties at the date transferred by the taxpayer (the“200% rule”). Reg. §1.1031(k)-1(c)(4)(i).

-54-

(c) EXAMPLE: T and S agreed to enter into a deferredexchange. Pursuant to the exchange agreement, T transferred real property X to S on May 20,2010. Real property X, which was held by T for investment, was unencumbered and had a fairmarket value on May 20, 2010 of $100,000. On May 20, 2010, T identified real properties A, B,C and D as replacement properties in a written document signed by T and personally delivered toS. The written document provided that by July 1, 2010, T would orally inform S which of theidentified properties S was to transfer to T. As of June 30, 2010, the fair market values of realproperties A, B, C and D were $30,000, $40,000, $50,000 and $60,000, respectively. AlthoughT identified more than three replacement properties, the aggregate fair market value of theidentified properties at the end of the identification period ($180,000) did not exceed 200 percentof the aggregate fair market value of real property X (200% times $100,000 = $200,000).Therefore, the requirements of the 200-percent rule were satisfied, and real properties A, B, Cand D were all properly identified as possible replacement properties for Sec. 1031, I.R.C.purposes. Reg. § 1.1031(k)-1(c)(7), Ex. 5.

(2) The “fair market value” of property means the fair marketvalue of the property without regard to any liabilities secured by the property. Reg. §1.1031(k)-1(m).

(3) Note: If the taxpayer has identified more properties at theend of the identification period than permitted by the 3-property rule or the 200% rule, then thetaxpayer is treated as if no replacement property had been identified by such time. Reg.§1.1031(k)-1(c)(4)(ii). This does not occur, however, as to --

(a) Any replacement property received by the taxpayerbefore the end of the identification period (Reg. §1.1031(k)-1(c)(4)(ii)(A)); and

(b) Any replacement property identified before the endof the identification period and received before the end of the exchange period, but only if thetaxpayer receives identified replacement property constituting at least 95% of the aggregate fairmarket value of all identified replacement properties before the end of the exchange period. Reg.§1.1031(k)-1(c)(4)(ii)(B).

e. Property that is “incidental to a larger item” (such as a tool kit in atruck, or refrigerators, dishwashers and laundry machines in an apartment building) is not treatedas separate from that larger item (for identification purposes only) if --

(1) In standard commercial transactions, the property istypically transferred together with the larger item; and

(2) The aggregate fair market value of all such incidentalproperty does not exceed 15% of the aggregate fair market value of the larger item. Reg.§1.1031(k)-1(c)(5).

f. Revocation of an identification of replacement property may occurat any time prior to the end of the identification period. Reg. §1.1031(k)-1(c)(6).

-55-

(1) An identification of replacement property made in a writtenagreement is treated as revoked only to the extent such revocation is made in a writtenamendment to that agreement or in a written document conforming to the identificationrequirements.

(2) Otherwise, revocation is made by written documentconforming to the identification requirements.

4. Receipt of Identified Replacement Property--

a. Generally, the identified replacement property is consideredreceived before the end of the exchange period if --

(1) The taxpayer in fact receives it before the end of theexchange period; and

(2) The replacement property received is substantially the sameproperty as identified. Reg. §1.1031(k)-1(d)(1). See Priv. Ltr. Rul. 200211016 (March 15,2002).

b. The “substantially the same property” criterion should be satisfiedif at least 75% of the fair market value of the identified replacement property is received. SeeReg. §1.1031(k)-1(d)(2), Ex.4(ii).

5. Identification and Receipt of Replacement Property to be Produced --

a. Generally, a deferred exchange will not fail merely because thereplacement property is not in existence or is being produced (which, under Sec. 263A(g)(1),I.R.C., includes constructed, built, installed, manufactured, developed or impaired) at the timethe property is identified as replacement property. Reg. §1.1031(k)-1(e)(1). See Priv. Ltr. Rul.9428007 (April 13, 1994) and Priv. Ltr. Rul. 9413006 (December 20, 1993).

b. For purposes of identification, it should be noted that:

(1) Where improvements are to be constructed on realproperty, a legal description is sufficient if it states the time period for construction and providesas much detail as practicable regarding the underlying land. Reg. §1.1031(k)-1(e)(2)(i).

(2) The fair market value of replacement property to beproduced is the estimated fair market value as of the date such property is expected to bereceived. Reg. §1.1031(k)-1(e)(2)(ii).

c. In determining whether the replacement property received by thetaxpayer is substantially the same as the replacement property identified, the following rulesapply:

-56-

(1) Variations due to usual or typical production changes arenot taken into account. Reg. §1.1031(k)-1(e)(3)(i).

(2) If substantial changes are made in the property to beproduced, the replacement property will not be considered to be substantially the same as theproperty identified. Reg. §1.1031(k)-1(e)(3)(i).

(3) Personal property will not be considered substantially thesame unless production is completed on or before the day received by the taxpayer. Reg.§1.1031(k)-1(e)(3)(ii).

(4) Real property will be considered substantially the sameonly if:

(a) The replacement property received constitutes realproperty under local law; and

(b) The replacement property received, had productionbeen completed on or before the date the taxpayer received the property, would have beenconsidered to be substantially the same property as identified. Reg. §1.1031(k)-1(e)(3)(iii).

(5) The deferred exchange rules are not met where therelinquished property is transferred in exchange for services (including production services).Accordingly, any additional production occurring after the replacement property is received bythe taxpayer will not be treated as the receipt of like kind property. Reg. §1.1031(k)-1(e)(4).

E. Coordination of Deferred Like Kind Exchange Rules with Installment Sale Rules .

1. Under the installment sale rules set forth in Sec. 453, I.R.C., income isgenerally taken into account proportionately as payments are received. However, under thedeferred like-kind exchange rules, certain safe harbors allow taxpayers to enter into qualifiedarrangements that do not result in the constructive receipt of money or other property forpurposes of the like-kind exchange rules. The Regulations provide rules that coordinate the safeharbor provisions of Reg. §1.1031(k)-1(g) with the installment sale rules that determine when ataxpayer is in receipt of a payment under Sec. 453, I.R.C. and Reg. §15a.453-1(b)(3)(i).

2. The Regulations basically provide that, if the taxpayer has a bona fideintent to enter into a deferred exchange at the beginning of the exchange period (as defined inReg. §1.1031(k)-1(b)(2)(ii)), then

a. Under Reg. §1.1031(k)-1(j)(2)(i), if the cash or cash equivalentsecuring a transferee’s obligation to transfer replacement property to the taxpayer is held in aqualified escrow account or a qualified trust (under Reg. §1.1031(k)-1(g)(3)), the taxpayer is notconsidered to have received a payment under Sec. 453, I.R.C. and Reg. §15A.453-1(b)(3)(i) until

-57-

the earlier of (i) the time that the taxpayer has the immediate ability or unrestricted right toreceive or otherwise obtain the benefits thereof, or (ii) the end of the exchange period; and

b. Under Reg. §1.1031(k)-1(j)(2)(ii), if such cash or cash equivalentis held by a QI (under Reg. §1.1031(k)-1(g)(4)), the QI is not considered the agent of thetaxpayer in determining whether the taxpayer has received a payment for purposes of Sec. 453,I.R.C. and Reg. §15A.453-1(b)(3)(i) until the earlier of (i) the time that the taxpayer has theimmediate ability or unrestricted right to receive or otherwise obtain the benefits thereof, or (ii)the end of the exchange period.

3. The Regulations apply to a transaction that ultimately fails to qualify as alike kind exchange because sufficient replacement property is either not identified or nottransferred to the taxpayer before the end of the replacement period. See Reg. §1.1013(k)-1(j)(2).

4. EXAMPLE: B has held real property X for use in its trade or business,but decides to transfer that property. B and D agree to enter into a deferred exchange. Pursuantto their agreement, B transfers real property X to D on September 22, 2009, and D deposits$100,000 cash in a qualified escrow account as security for D's obligation under the agreement totransfer replacement property to B before the end of the exchange period. D's obligation is notpayable on demand or readily tradable. The agreement provides that B is not required to acceptany property that is not zoned for commercial use. Before the end of the identification period, Bidentifies real properties J, K, and L, all zoned for residential use, as replacement properties. Anyone of these properties, rezoned for commercial use, would be suitable for B's plannedexpansion. The escrow agreement provides that B has no rights to receive, pledge, borrow orotherwise obtain the benefits of the money in the escrow account until the earlier of the time that(i) the zoning board determines, after the end of the identification period, that it will not rezonethe properties for commercial use or (ii) the exchange period ends. On January 5, 2010, thezoning board decides that none of the properties will be rezoned for commercial use. Pursuant tothe exchange agreement, B receives the $100,000 cash from the escrow on January 5, 2010.Under Sec. 1001, I.R.C., B realizes gain to the extent of the amount realized ($100,000) over theadjusted basis of real property X ($60,000), or $40,000. The terms of the exchange agreementwith D, the identification of properties J, K and L, the efforts to have those properties rezoned forcommercial purposes, and the absence of other relevant facts all indicate that B had a bona fideintent at the beginning of the exchange period to enter into a deferred exchange. Moreover, thelimitations imposed in the exchange agreement on acceptable replacement property do not makeit unreasonable to believe that like-kind replacement property would be acquired before the endof the exchange period. Even though B fails to acquire replacement property, the qualifiedescrow account is disregarded in determining whether B is in receipt of payment under Sec. 453,I.R.C. As a result, B is not treated as having received payment on September 22, 2009 and,instead, is treated as receiving payment on January 5, 2010. Reg. §1.1031(k)-1(j)(2)(vi), Ex. 6.

5. Furthermore, in order to protect the taxpayer from ultimately not beingable to use the installment method if the like kind exchange does not materialize, the evidence ofindebtedness of a transferee from the QI is treated as if it were the debt of the person acquiringthe property from the taxpayer for purposes of Sec. 453, I.R.C. and Reg. §15A.453-1(b)(3)(i).Reg. §1.1031(k)-1(j)(2)(ii).

-58-

6. See Smalley v. Comm’r, 116 T.C. 450 (2001). The Court’s analysis inthis case focused on the coordination of Secs. 453 and 1031, I.R.C. The taxpayer ownedsubstantial acreage of standing timber in Georgia. The taxpayer transferred the right to cuttimber for a term of two years on 95 acres of standing timber in exchange for consideration in theamount of $517,076. The taxpayer entered into a timber contract, a memorandum of contract, atax-free exchange agreement and an escrow agreement to effect the exchange. The transfer ofthe standing timber occurred in 1994, when the amount of the purchase price was deposited withan escrow agent. In 1995, the taxpayer acquired a fee simple interest in three parcels of realproperty with the proceeds of sale held in the escrow account. The tax-free exchange agreementprovided that the taxpayer would designate such replacement property to be acquired andtransferred to the taxpayer. The purchaser’s obligation to acquire the taxpayer’s replacementproperty was secured by the amount of cash held in the escrow account.

The Court addressed the issue of whether the taxpayer was required to recognize gainfrom the sale of the timber cutting rights in 1994. The Court considered whether the taxpayerhad actively or constructively received property in 1994. The taxpayer argued successfully thatthe transaction qualified as a deferred like kind exchange eligible for nonrecognition treatmentunder Sec. 1031, I.R.C. The terms of the tax-free exchange agreement and escrow agreementsatisfied the requirements of Reg. § 1.1031(k)-1(g)(3). The taxpayer had the requisite intent toenter into a deferred like kind exchange transaction according to Reg. § 1.1031(k)-1(j)(2).Consequently, the taxpayer did not actively or constructively receive the cash purchase pricedeposited with the escrow agent in 1994.

VII. REVERSE EXCHANGES

A. Basics -- There may be situations in which a transferor needs to receive thereplacement property before transferring the property to be relinquished. For example, thetaxpayer may fear that his desired replacement property will be sold to another buyer. There isnothing in the Code which prohibits this type of transaction. However, there is nothing in theCode or Regulations which expressly provides for this type of transaction. The Preamble to theDeferred Like Kind Exchange Regulations states that Sec. 1031(a)(3), I.R.C. does not apply toreverse-Starker exchanges, but that the Service will continue to study the applicability of Sec.1031(a)(1), I.R.C. to these transactions. See Preamble, T.D. 8346, 1991-1 C.B. 150, 151. Seealso Rev. Proc. 2000-37, 2000-2 C.B. 308, discussed below.

B. Types of Reverse Exchanges -- There are several variations of the reverse likekind exchange transaction that taxpayers have undertaken in order to avoid concurrent ownershipof the replacement property and the property to be relinquished.

1. Pure or True Reverse Deferred Exchange -- In what is referred to as a pureor true reverse exchange, the taxpayer who is the exchangor acquires the replacement propertyfirst and subsequently sells the property to be relinquished. No accommodation partyparticipates in the transaction.

-59-

2. Park Relinquished Property (Exchange First) -- The accommodation partyacquires the replacement property first. The accommodator then simultaneously exchanges thereplacement property for the relinquished property with the taxpayer who is the exchangor. Theaccommodation party holds the relinquished property until the property is sold.

3. Park Replacement Property (Exchange Last) -- The accommodation partyacquires the replacement property and holds the replacement property until the exchangor isready to sell and transfer the property to be relinquished. Subsequently, the exchangor transfersthe relinquished property to the accommodation party who transfers the replacement property tothe exchangor in a simultaneous or deferred exchange. The taxpayer may provide a loan to theintermediary to fund the down payment, with the remainder financed through the use of arecourse or nonrecourse mortgage. When the taxpayer receives the replacement property, he orshe may typically either assume a recourse mortgage or take the property subject to anonrecourse mortgage.

4. Lease and Option to Purchase -- The taxpayer leases the replacementproperty with an option to buy and enters into a simultaneous exchange when the purchaseoption is exercised. However, the lease-option transaction could be recharacterized as a currentsale, so additional care is advisable.

C. Level of Risk --

1. The reverse like kind exchange is problematic because it was not officiallysanctioned by the Service until Rev. Proc. 2000-37, 2000-2 C.B. 308. See Reg.§1.1031(k)-1(a) (defining a like kind exchange as one “in which, pursuant to an agreement, thetaxpayer transfers property . . . and subsequently receives property”). But see Priv. Ltr. Rul.9814019 (December 23, 1998), modified by Priv. Ltr. Rul. 9823045 (March 10, 1998) (utilitywill acquire power line easement and subsequently transfer existing easement at an indefinitelater time).

2. The taxpayer-intermediary relationship may be characterized as aprincipal-agent relationship with the taxpayer being in constructive receipt of the sale proceeds.Technically, Reg. §1.1031(k)-1 is not intended to apply to reverse exchanges. Consequently,reverse exchanges may be characterized according to basic agency principles and theconstructive receipt rules would have similar application. However, it is now more likely thatreverse exchanges will qualify for nonrecognition treatment under Sec. 1031, I.R.C. as a result ofthe new safe harbor provisions of Rev. Proc. 2000-37.

3. In Priv. Ltr. Rul. 200329021 (February 21, 2003), the Service concludedthat the taxpayer’s proposed exchange of property held for productive use through a QI and anEAT conformed with the requirements of the QI and QEAA safe harbor rules provided by Rev.Proc. 2000-37.

Here, Taxpayer, a wholly owned subsidiary of Parent, proposed to create a QEAA byentering into an agreement with Company, which would serve as both a QI and an EAT in thistransaction. Pursuant to the QEAA Agreement, LLC, a single-member LLC wholly owned by

-60-

Company and disregarded for Federal income tax purposes, accepted an assignment from Parentof a leasehold interest in Site Y (Leasehold Interest) on Date 1. Under the laws of the statewhere Site Y is located, the Leasehold Interest is considered a real property interest. On thesame date as the assignment, Taxpayer also entered an Exchange Agreement with Company eventhough it did not own the Leasehold Interest. LLC will construct and own a building(Improvements) on Site Y pursuant to Parent’s design. LLC is expected to complete theconstruction project by Date 2 (a date within 180 days after the earlier of the transfer ofLeasehold Interest to LLC or the date LLC acquires title to the Leasehold Interest).

Under the Exchange Agreement, Taxpayer will identify, within the 45-day period setforth in Sec. 1031(a)(3), I.R.C., and in a written instrument delivered to the QualifiedIntermediary (Company), the legal description of the Leasehold Interest and a generaldescription of the Improvements to be constructed on the Leasehold Interests. The QualifiedIntermediary will not take title to either the Relinquished Property or the Replacement Property.

Under the QEAA Agreement, Taxpayer will identify, within the 45-day period beginningon Date 1, the Relinquished Property disposed of under the Exchange Agreement as the realproperty being exchanged for the Replacement Property held under the QEAA Agreement.

Within 180 days after the earlier to occur of (i) the conveyance of the RelinquishedProperty and (ii) LLC’s acquisition of the Replacement Property in the form of the LeaseholdInterest and Improvements, Taxpayer will, under the Exchange Agreement and the QEAAAgreement, acquire the Leasehold Interest and the Improvements to complete the exchange.

In holding that this proposed transaction qualifies for like kind treatment, the Serviceobserved that, if the planned improvements are not completed within the exchange period,Taxpayer will recognize gain to the extent of any boot received in the exchange. Also, to theextent that the estimated cost of the Improvements is less than the qualified funds held byQualified Intermediary, if Taxpayer does not timely identify and acquire additional like kindreplacement property, Taxpayer will receive the remaining funds as boot.

D. Authority Prior to Rev. Proc. 2000-37 --

1. In Rutherford v. Comm’r, T.C. Memo. 1978-505, Wardlaw, the transferee,transferred 12 half-blood cows to the taxpayer, Rutherford, in exchange for 12 three quarter-blood cows to be transferred at some later time. The 12 three quarter-blood cows were to be theproduct of the 12 half-blood cows. The agreement provided for no future cash obligation in theevent the half-blood cows could not reproduce. The Tax Court upheld the transaction as a validSec. 1031(a), I.R.C. exchange as to Rutherford.

2. In Bezdjian v. Comm’r, 845 F.2d 217 (CA9 1988), the taxpayers, theBezdjians, were offered ownership of a gas station they operated under a lease. The sellerrefused to trade the gas station for other rental property owned by the Bezdjians. Therefore, theBezdjians purchased the gas station and, approximately three weeks thereafter, sold the rentalproperty to a third party. The Ninth Circuit affirmed the Tax Court holding that there was noSec. 1031, I.R.C. exchange as to the Bezdjians. The Bezdjian case is distinguishable from the

-61-

Rutherford case. First, the Bezdjians did not have any agreement to exchange properties withanyone. Second, they received the replacement property from a person different from the one towhom they transferred the relinquished property.

3. In Dibsy v. Comm’r, 70 TCM 918 (1995), the taxpayers arguedunsuccessfully that they had entered into a reverse like kind exchange. The taxpayers owned oneliquor store that they sold following the purchase of a second liquor store. The taxpayersattempted to link the purchase and sale of the two liquor stores as part of an integrated like kindexchange transaction. The Court noted that the purchase and sale were not structured as a likekind exchange because (i) the escrow documents from the sale did not refer to a like kindexchange; (ii) there was no evidence to show that a like kind exchange was intended; and (iii) thepurchasers of the sold liquor store were not aware that a like kind exchange was intended.

4. See Tech. Adv. Mem. 200039005 (May 31, 2000), where the taxpayerintended to engage in a deferred like kind exchange transaction. The taxpayer entered into acontract for the sale of relinquished property and assigned the contract to an accommodator. Itwas the responsibility of the accommodator to close the deal for the sale of the relinquishedproperty and to use the proceeds from the sale of the relinquished property to acquirereplacement property for the taxpayer. The attempted sale of the relinquished property fellthrough at closing. The seller of the replacement property demanded to close immediately on thesale of the replacement property. The taxpayer closed on the purchase of the replacementproperty before selling the relinquished property. The accommodator held title to thereplacement property even though the taxpayer had negotiated and financed the purchase. Whilethe accommodator held title to the replacement property, the taxpayer entered into anothercontract for the sale of the relinquished property and then assigned the contract to theaccommodator. The accommodator transferred the replacement property to the taxpayer afterthe closing of the sale of the relinquished property. The Service concluded that the taxpayer hadentered into a reverse Starker transaction rather than a forward deferred like kind exchangebecause the taxpayer first acquired the replacement property through the use of an agent and thensubsequently sold the relinquished property. The taxpayer was not eligible for nonrecognitiontreatment under Sec. 1031, I.R.C. because the transaction lacked the interdependence whichordinarily characterizes an exchange.

E. Rev. Proc. 2000-37: Safe Harbor for Parking Arrangements --

1. Rev. Proc. 2000-37, 2000-2 C.B. 308, sets forth a safe harbor fortaxpayers to qualify certain reverse like kind exchanges under Sec. 1031, I.R.C. Generally, in areverse like kind exchange, sometimes referred to as a “reverse Starker” transaction, thereplacement property is acquired before the property to be relinquished is transferred. Asdiscussed more fully below, the Service recently limited the scope of Rev. Proc. 2000-37 tocombat a perceived abuse of the safe harbor. See Rev. Proc. 2004-51, 2004-2 C.B. 294.

2. If a transaction meets the stated requirements of the safe harbor, ataxpayer may treat an accommodation party as the owner of the property for purposes of Sec.1031, I.R.C. Similarly, property will qualify as either the replacement property or therelinquished property if the requirements are met.

-62-

3. Parking Transactions -- The Service recognized in Rev. Proc. 2000-37 thattaxpayers have engaged in certain “parking transactions” to facilitate reverse like kindexchanges. In such parking transactions, the taxpayer temporarily stores the replacementproperty or the relinquished property with an intermediary in order to complete the like kindexchange in either a simultaneous or deferred transaction. The parking transactions described inRev. Proc. 2000-37 are consistent with the types of reverse exchanges referenced above.However, it is possible that other variations of parking transactions may fall within the scope ofthe safe harbor.

a. Parking Transaction No. 1 -- Rev. Proc. 2000-37 references onetypical parking transaction in which the replacement property is “parked” with anaccommodation party until such time as the taxpayer arranges to transfer the relinquishedproperty to the ultimate transferee in a simultaneous or deferred exchange.

b. Parking Transaction No. 2 -- In another representative transactionreferenced in Rev. Proc. 2000-37, an accommodation party acquires the desired replacementproperty on behalf of the taxpayer, and then exchanges such property with the taxpayer for therelinquished property in a simultaneous exchange. The accommodation party then holds therelinquished property until the relinquished property can be transferred to a third party.

4. QEAA Requirements -- If property is held in a QEAA, the Service will notchallenge the qualification of property as either replacement or relinquished property, or thetreatment of an EAT as the beneficial owner. Property is treated as held in a QEAA if thetaxpayer meets the following six requirements:

a. Incidents of Beneficial Ownership -- An EAT must hold theincidents of beneficial ownership of the property intended as either the replacement or therelinquished property. The EAT cannot be the taxpayer and must be subject to Federal incometax at all times from the date of acquisition until the property is transferred. Property may still betreated as held in a QEAA even though subject to certain contractual arrangements includingleases, guarantees or indemnification.

b. Bona Fide Intent -- The taxpayer must have a bona fide intent thatthe property held by the EAT is either the replacement or the relinquished property as part of alike kind exchange intended to qualify for nonrecognition treatment under Sec. 1031, I.R.C.

c. QEAA -- The taxpayer and the EAT must enter into a QEAA nolater than five business days after the transfer of beneficial ownership of the property to the EAT.

d. Identification within 45 Days -- The taxpayer must identify therelinquished property within 45 days after the transfer of beneficial ownership of the replacementproperty to the EAT.

-63-

e. Transfer of Property from EAT within 180 Days -- The propertymust be transferred to the taxpayer as the replacement property or to a third party as therelinquished property within 180 days after the transfer of beneficial ownership to the EAT.

f. 180 Day Limit for Property Held in OEAA -- The combined timeperiod during which the replacement property and the relinquished property are held in a QEAAcannot exceed 180 days.

5. Relinquished Property Used in Two Exchanges -- In Chief Counsel Advice200836024 (May 12, 2008), Taxpayer engaged in a reverse exchange whereby replacementproperty was acquired and parked with an exchange accommodation titleholder before theTaxpayer transferred its relinquished property. Taxpayer identified the relinquished property ina timely manner. However, because the value of the relinquished property was substantiallygreater than that of the replacement property, Taxpayer also attempted to engage in a standarddeferred exchange where the relinquished property would be relinquished and replaced byanother property. The Service sanctified the use of the same relinquished property in bothexchanges.

6. Rev. Proc. 2004-51 -- Recognizing that some taxpayers were using Rev.Proc. 2000-37 to enter reverse like kind exchanges to construct improvements on property theyowned, the Service issued Rev. Proc. 2004-51, 2004-2 C.B. 294, which provides that the safeharbor in Rev. Proc. 200-37 will not apply if the taxpayer owns the property intended to qualifyas the replacement property within the 180-day period immediately preceding the transfer of theproperty to the QEAA. Rev. Proc. 2004-51 applies to transfers on or after July 20, 2004.

a. Disappearing Lease -- The transaction that concerned the Serviceand prompted the modification of Rev. Proc. 2000-37 involves a reverse like kind exchange inwhich a taxpayer leases property to an EAT for a period of not less than 30 years, the EATconstructs improvements on the leased property, and the EAT then conveys the leasehold back tothe taxpayer. Because Rev. Proc. 2000-37 stated the Service would not challenge theclassification of property as “replacement property” if the property was held in a QEAA,taxpayers were able to use the disappearing lease to construct improvements on their property.

b. Implications of Rev. Proc. 2004-51 -- Although Rev. Proc. 2004-51 clearly takes aim at build-to-suit like kind exchanges in which the taxpayer directly owned theproperty involved in the exchange, it does not appear to prohibit the continued availability of thesafe harbor in Rev. Proc. 2000-37 for exchanges to construct improvements on property held byan affiliate of the taxpayer. Thus, the type of build-to-suit exchange described in Priv. Ltr. Rul.200251008 (December 20, 2002), discussed below, should still be within the safe harbor, even asmodified by Rev. Proc. 2004-51. The Service, nevertheless, stated in Rev. Proc. 2004-51 that itintends to continue studying parking transactions, especially those in which a person related tothe taxpayer transfers a leasehold in land to an accommodation party and the accommodationparty makes improvements to the land and transfers the leasehold with the improvements to thetaxpayer in exchange for other real estate.

-64-

F. Build-to-Suit Rulings --

1. DeCleene v. Comm’r, 115 T.C. 457 (2000) -- The taxpayer purchasedimproved real property (McDonald Street) in 1976 for use in the operation of a truckingbusiness. The taxpayer purchased unimproved real property (Lawrence Drive) on September 30,1992 and financed the acquisition with a nonrecourse mortgage from a bank. On September 24,1993, the taxpayer entered into an Exchange Agreement with Western Lime and Cement Co.(WLC). The agreement provided that the taxpayer would transfer the Lawrence Drive propertyto WLC by quitclaim deed in exchange for WLC’s note in the amount of $142,400. Theagreement required WLC to construct a building on the unimproved Lawrence Drive propertyaccording to the taxpayer’s specifications. WLC financed the construction of the building with aloan in the amount of $380,000 guaranteed by the taxpayer.

On December 29, 1993, the taxpayer assumed WLC’s construction financing loan as theborrower. Following the construction of the building on the Lawrence Drive property, thetaxpayer conveyed the McDonald Street property to WLC. In exchange for the McDonald Streetproperty, WLC paid off its note on the Lawrence Drive property and reconveyed the LawrenceDrive property to the taxpayer by quitclaim deed. On his Federal income tax return for 1993, thetaxpayer treated the transaction as (1) a sale of the unimproved Lawrence Drive property, and (2)a like kind exchange of the McDonald Street property for the improved Lawrence Driveproperty.

The Court determined that the transaction at issue was a reverse like kind exchange(parking transaction) between the taxpayer and WLC without the participation of a third-partyexchange accommodator. Consequently, the transfer of the McDonald Street property resulted ina taxable sale because the burden and benefits of ownership remained with the taxpayer. Thetransfer of the Lawrence Drive property to WLC by quitclaim deed only conferred bare legaltitle, did not give rise to any equity interest, and did not place WLC “at risk” with respect to theproperty. The reconveyance of the Lawrence Drive property effectively restored bare legal titlewith the taxpayer’s beneficial ownership that was retained while WLC constructed the newbuilding.

The Court held that the parking transaction in DeCleene did not qualify fornonrecognition treatment under Sec. 1031, I.R.C. and the transfer of the McDonald Streetproperty constituted a sale because:

a. The taxpayer did not locate and identify the Lawrence Driveproperty in order to acquire it as replacement property;

b. The taxpayer purchased the Lawrence Drive property, without theparticipation of an exchange intermediary, one year or more before relinquishing the McDonaldStreet property;

c. The taxpayer transferred title to the anticipated replacementproperty to the acquiror of the relinquished property rather than to a third party exchangefacilitator; and

-65-

d. The holding of title to the Lawrence Drive property by WLC didnot bear any economic significance.

2. In Priv. Ltr. Rul. 200251008 (December 20, 2002), the Service interpretedthe scope of Rev. Proc. 2000-37 for the first time and concluded the taxpayer’s build-to-suitexchange with a related party qualified for Sec. 1031, I.R.C. nonrecognition treatment.

In this situation, the taxpayer, an S corporation, sought to relocate its business, through alike kind exchange, to a parcel of unimproved land currently leased by another related Scorporation. To this end, the taxpayer proposed to enter into the QEAA with an EAT, and toenter an exchange agreement with a QI. As part of the overall transaction, the second Scorporation would sublease the real property for fair market rental to a limited liability company(LLC) wholly owned by EAT. The taxpayer then would lend funds to LLC to constructimprovements necessary for the relocation of the taxpayer’s business. In addition, the taxpayerwould assign its rights and interests in the real property where its business was currently locatedto QI, which would use the proceeds from the sale of the taxpayer’s property to pay EAT for allof its interests in LLC. The EAT will use these proceeds from QI to pay LLC, which ismanaging the construction of the premises for the taxpayer’s new business location, and to repaythe loan from the taxpayer. Finally, QI will direct EAT to transfer its interest in LLC, whichholds title to the real property where the taxpayer’s new business will be located, directly to thetaxpayer.

The Service ruled that the proposed transaction conformed with the requirements of thesafe harbor rules for QIs and QEAAs. Because the QI and EAT employed in this transactionwere not considered the taxpayer’s agents, the taxpayer was not in actual or constructive receiptof money or other property prior to receiving the replacement property. Accordingly, thetaxpayer did not recognize any gain or loss on the exchange. However, if the plannedimprovements on the subleased property are not completed within the exchange period, then, aspointed out by the Service, the taxpayer will recognize gain to the extent of any boot received inthe exchange.

3. Similarly, in Priv. Ltr. Rul. 200329021 (February 21, 2003), the Serviceagain concluded that the taxpayer’s proposed exchange of property held for productive usethrough a QI and an EAT conformed with the requirements of the QI and QEAA safe harborrules provided by Rev. Proc. 2000-37.

Here, Taxpayer, a wholly owned subsidiary of Parent, proposed to create a QEAA byentering into an agreement with Company, which would serve as both a QI and an EAT in thistransaction. Pursuant to the QEAA Agreement, LLC, a single-member LLC wholly owned byCompany and disregarded for Federal income tax purposes, accepted an assignment from Parentof a leasehold interest in Site Y (Leasehold Interest) on Date 1. Under the laws of the statewhere Site Y is located, the Leasehold Interest is considered a real property interest. On thesame date as the assignment, Taxpayer also entered an Exchange Agreement with Company eventhough it did not own the Leasehold Interest. LLC will construct and own a building(Improvements) on Site Y pursuant to Parent’s design. LLC is expected to complete the

-66-

construction project by Date 2 (a date within 180 days after the earlier of the transfer ofLeasehold Interest to LLC or the date LLC acquires title to the Leasehold Interest).

Under the Exchange Agreement, Taxpayer will identify, within the 45-day period setforth in Sec. 1031(a)(3), I.R.C., in a written instrument delivered to the Qualified Intermediary(Company), the legal description of the Leasehold Interest and a general description of theImprovements to be constructed on the Leasehold Interests. The Qualified Intermediary will nottake title to either the Relinquished Property or the Replacement Property.

Under the QEAA Agreement, Taxpayer will identify, within the 45-day period beginningon Date 1, the Relinquished Property disposed of under the Exchange Agreement as the realproperty being exchanged for the Replacement Property held under the QEAA Agreement.

Within 180 days after the earlier to occur of (i) the conveyance of the RelinquishedProperty and (ii) LLC’s acquisition of the Replacement Property in the form of the LeaseholdInterest and Improvements, Taxpayer will, under the Exchange Agreement and the QEAAAgreement, acquire the Leasehold Interest and the Improvements to complete the exchange.

In holding that this proposed transaction qualifies for like kind treatment, the Serviceobserved that, if the planned improvements are not completed within the exchange period,Taxpayer will recognize gain to the extent of any boot received in the exchange. Also, to theextent that the estimated cost of the Improvements is less than the qualified funds held by QI,then if Taxpayer does not timely identify and acquire additional like kind replacement property,Taxpayer will receive the remaining funds as boot.

G. Joint Committee on Taxation Recommendations for Simplification --

1. Election to Roll Over Gain -- In April 2001, the Joint Committee onTaxation published recommendations for simplification of the like kind exchange provisions. Inthe first recommendation, the Joint Committee proposed that a taxpayer should be permitted toelect to roll over gain from the disposition of appreciated business or investment propertydescribed in Sec. 1031, I.R.C. The taxpayer would be entitled to make the election if thetaxpayer acquired the like kind property within 180 days before or after the date of disposition(but not later than the due date of the taxpayer’s income tax return). The election would allowtaxpayers to reinvest the proceeds from the sale of business or investment property directly intoother like kind property. A taxpayer would recognize gain only to the extent that proceeds fromthe property sold are not reinvested in eligible replacement property. The proposed electionwould reduce the taxpayer’s burden of compliance with the current complicated statutory andregulatory requirements. The proposed election also would eliminate the need to use anintermediary and would reduce transaction costs. Joint Committee Print, Vol. II:Recommendations of the Staff of the Joint Committee on Taxation to Simplify the Federal TaxSystem 300-305 (April 2001).

2. Holding period and Use Requirements -- The Joint Committee alsoproposed to simplify the holding requirement under Sec. 1031, I.R.C. The recommendationproposes that, in the case of certain transactions, the holding period and use of property

-67-

transferred in a like kind exchange should be broadened to include both the taxpayer’s and theprior transferor’s holding period and use of property. Specifically, the transferor’s holdingperiod and use of property would “tack” to the extent that (1) property is contributed to acorporation in a Sec. 351, I.R.C. transaction or to a partnership under Sec. 721, I.R.C.; (2) acorporation acquires property in connection with a reorganization under Sec. 368, I.R.C.; (3) apartnership distributes property to a partner; or (4) a corporation distributes property in atransaction subject to Sec. 332, I.R.C. The recommendation is also intended to prevent (1)relinquished property from being converted from personal use to investment or (trade orbusiness) use before an exchange, or (2) replacement property from being converted frominvestment (or trade or business) use to personal use after an exchange. Joint Committee Print,Vol. II: Recommendations of the Staff of the Joint Committee on Taxation to Simplify theFederal Tax System 300-305 (April 2001).

VIII. CHECKLIST FOR DEFERRED LIKE KIND EXCHANGES

Sample Checklist of Steps to Accomplish a Deferred Exchange

These steps assume that the replacement property and relinquished property are not specificallyexcluded from Sec. 1031 treatment (i.e., stock in trade or other property held primarily for sale;stocks, bonds or notes; other securities or evidence of debt or interest; interests in a partnership,certificates of trusts or beneficial interests; or choses in action). If you are unsure, please reviewthe rules of Sec. 1031(a)(2), I.R.C.

YES ____ NO ____ 1. Have you identified a replacement property? If yes,continue. If no, will you be able to identify such aproperty within the deferred exchange time limits?

YES ____ NO ____ 2. If Transferee does not own a suitable replacementproperty, will Transferee acquire one? If yes, use aqualified escrow or trustee. If no, continue with thischecklist.

YES ____ NO ____ 3. Is the Transferee a related party? Related parties aregenerally entities which are owned by the same interests.If answer is yes or you are unsure, please review therules of Section 1031(f).

YES ____ NO ____ 4. Does your property have a mortgage? If yes, a decisionmust be made as to its disposition:

A. ____ paid off prior to exchange.

B. ____ being assumed/taken subject to in transfer.

Note: If mortgage is being assumed/taken subject to,please review the rules of Reg. § 1.1031(b)-1(c).

-68-

YES ____ NO ____ 5. Was the property which is to be exchanged (1) acquiredfor the purposes of effectuating a like kind exchange or(2) acquired as part of a portfolio purchase and isundesired? If yes, the property may not qualify to be usedin a like kind exchange.

YES ____ NO ____ 6. In the case of property which is being disposed of by aREIT, has the property been held for at least two years(four years for exchanges prior to July 31, 2008)? If no,please review the rules of Section 857(b)(6)(C).

YES ____ NO ____ 7. Is the replacement property of like kind? Although thelike kind rules are permissive relative to the type ofreal estate exchanged, if personal property will beexchanged incidental to the exchange of real property,such property will be boot unless it also is exchangedfor like kind property.

YES ____ NO ____ 8. Is the replacement property going to be property which isto be produced or constructed? If it is, please review therules of Reg. § 1.1031(k)-1(e).

9. How will your settlement costs be paid?

A. Payment with separate funds

B. Transferee will be paying all settlement costs

C. Payment with settlement proceeds

If choice is C., the transaction may not be tax-free tothe extent of such costs.

DONE ____ 10. Verify that the Qualified Intermediary is not your agent.If you are unsure, please review Reg. § 1.1031(k)-1(k)(2).

DONE ____ 11. Verify that the Qualified Intermediary is not an attorney,accountant, investment banker, broker, real estate agentor employee who has (1) acted for you in the 2 yearsprior to your expected settlement date, and (2) performedservices other than routine institutional services orservices related to a like kind exchange. If you areunsure, please review Reg. § 1.1031(k)-1(k)(2).

-69-

DONE ____ 12. Verify that the Qualified Intermediary does not bear adirect family relationship or affiliation to you or youragents. If you are unsure, please review Reg. §1.1031(k)-1(k)(2).

DONE ____ 13. Verify that you will have no rights to receive, pledge,borrow or otherwise obtain the benefits of the cash orcash equivalents held in the escrow or trust. If you do oryou are unsure, please note that such rights willdisqualify the like kind exchange.

YES ____ NO ____ 14. Will you be using security or guarantee arrangements? Ifso, the following forms of security or guaranteearrangements are acceptable:

A. A mortgage, deed of trust or other security interest(other than cash or its equivalent) in your property.

B. A letter of credit (1) issued by a bank or a financialinstitution which is (2) non-negotiable, (3)nontransferable, and (4) that may not be drawn uponin the absence of default.

C. A third-party guarantee.

If other forms of security are used, consult your taxadvisor.

DONE____ 15. Verify that you do not have an immediate ability orunrestricted right to receive money or other propertyfrom this security or guarantee arrangement. Please notethat such rights will disqualify the like kind exchange.

YES___ NO____ 16. While the proceeds are held with the QualifiedIntermediary, will there be interest or some other growthfactor?

YES ____ NO ____ 17. Is this interest or growth factor calculated based on thetime period that such proceeds are held by the QualifiedIntermediary? If no, please consult your tax advisor.

DONE ____ 18. Verify that you do not have an immediate ability orunrestricted right to receive this interest or growth factor.Please note that such rights will disqualify the likekind exchange.

-70-

19. Choose one of the alternative courses of action. (Method1 is preferred).

DONE ____ (1) You enter into an Exchange Agreement with aQualified Intermediary, and this Intermediary andthe Transferee enter into a sales agreement.

DONE ____ (2) You enter into a sales agreement for your propertywith the Transferee. You provide, at a minimum, inthe Sales Agreement for the Transferee’scooperation in effectuating a like kind exchange.You must then assign the contract to the QualifiedIntermediary.

DONE ____ 20. At the date of settlement on the disposition of yourproperty, verify there are two settlement sheets onewhich transfers the property from you to the QualifiedIntermediary and one which transfers the property fromthe Qualified Intermediary to the Transferee.

DONE ____ 21. At the date of settlement on the disposition of yourproperty, the settlement sheet for the transfer from theTransferee to the Intermediary should be modified toprovide:

A. Proceeds from Transferee are to be paid to theIntermediary. Set forth in a footnote of SettlementSheet the following: “Transferor and Transfereehereby acknowledge that Transferor has notreceived any of the Escrow Proceeds in connectionwith the transactions described herein, and thatsuch Escrow Proceeds are to be used by Transfereeto acquire and convey (or cause to be acquired andconveyed) to Transferor property which isintended to qualify as ‘like kind’ pursuant to theInternal Revenue Code of 1986 and the TreasuryRegulations thereunder.”

B. Proceeds are designated as “Escrow Proceeds” ofQualified Intermediary as opposed to “Due toSeller.”

DONE____ 22. At the date of settlement on your property, the QualifiedIntermediary may deliver to you a designation letterinstructing you to convey title to Transferee.

-71-

23. Within 45 days of the settlement on your property, youmust properly identify replacement property as follows:

DONE____ A. Unambiguously describe the property through a (1)legal description, (2) street address, or (3)distinguishable name.

DONE____ B. Identify the property in a written document signedby the appropriate person at your company.

DONE____ C. Send the letter either to (1) the person obligated totransfer the replacement property or (2) any otherperson involved in the transaction who is not adisqualified person.

D. If several alternative properties were identified, thefollowing requirements must be met:

YES____ NO____ (1) Are three or less properties identified? If morethan three properties will be identified, thenyou must satisfy one of the followingrequirements:

YES____ NO____ (a) If more than three properties were identified,did you revoke any designations so that thenumber of nonrevoked properties was threeor less?

YES____ NO____ (b) Were the designations properly revoked witha written, signed letter sent to the person towhom the identification statement was sentnot later than 45 days since the settlementdate on your property? If answers to (a) and(b) are no, go to question (c).

DONE____ (c) Identify properties whose values are lessthan or equal to 200% of the fair marketvalues of the properties relinquished on thesettlement date of your property. Consultyour tax advisor.

24. Choose one of the alternative courses of action (Method1 is preferred):

-72-

DONE____ (1) The Qualified Intermediary must enter into a directcontract with the seller of the replacement propertywithin 180 days after the settlement date on yourproperty.

DONE____ (2) You enter into a purchase agreement for thereplacement properties and assign the contract to theIntermediary. Verify that the Seller agreed to permitassignment either in the sales agreement, by consent,or at a minimum by agreeing in writing to cooperatein effectuating a like kind exchange.

DONE____ 25. Settlement must occur on the replacement propertywithin 180 days of the settlement date on your property.Please note, as set forth in Rev. Proc. 2010-14, 2010-12I.R.B. 456, under certain circumstances, you may beentitled to an extension of the 180-day replacementperiod (i.e., your QI failed to complete the like-kindexchange because it entered into bankruptcy orreceivership). Please consult your tax advisor.

DONE____ 26. At the date of settlement on the replacement property,verify there are two settlement sheets one which transfersthe property from the seller to the Intermediary and onewhich transfers the property from the Intermediary toyou.

DONE____ 27. Verify that both settlement sheets are modified toprovide:

DONE____ A. Purchaser is both you and the Intermediary (as anAccommodation Purchaser).

DONE____ B. Intermediary (as Accommodation Purchaser)authorizes and instructs Seller to convey thereplacement property to you pursuant to aDesignation letter.

DONE____ 28. At the date of settlement on the replacement property, theIntermediary may deliver to the Seller an instruction anddesignation letter instructing Seller to convey title to you.

DONE____ 29. The proceeds held by the Intermediary must not be heldby you or subject to your control or enjoyment.

like-kind exchange planning in real estate, part 1 & … · like-kind exchange planning in real...

Documents